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Is this UK share’s 25% dividend too good to be true?

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When building the income portion of my portfolio, I often look for UK shares that provide above-average dividend yields. These also tend to feature strong underlying fundamentals. The current FTSE 350 average dividend is 4%, so any company offering something in excess of this level is tempting.

I was, therefore, very interested when I noticed that Synthomer (LSE: SYNT) was offering a dividend yield of 24.8%. The company supplies a range of chemicals used in industries such as construction. Its share price has struggled considerably over the last year, and is down 70.8% in 2022. This follows a fall of over 11% in 2021.

Intriguing fundamentals

Given the large yield being offered, I think Synthomer is a great income opportunity. It has consistently paid a dividend for the last 12 years and can comfortably cover its yield by current earnings. Synthomer has high-profit margins, good earning efficiency, and reasonable cash generation. These are promising signs, and help support this current dividend.

Another unique factor is the current price-to-earnings (P/E) ratio of just 1.6. This is unbelievably low, given the index average is around 10. The share price fall has had a sizeable impact on the P/E, with the 2023 forecast P/E only reaching 4.2. Even after this forecast increase it is still significantly below the three-year average level. It also has a price-to-net asset value of 0.6, indicating that the market capitalisation is 60% of its net assets. These metrics can sometimes represent a significant value investment opportunity or instead suggest something is wrong.

Warning signs

In this case, as with many tempting high-yield investments, things may be too good to be true. The company’s dividend is forecast to fall by a massive 61.9% in the next year, resulting from a forecast decline in earnings. Despite the fact that turnover is forecast to grow over 12% next year, earnings per share (EPS) is expected to fall by over 60%.

Furthermore, debt levels have risen significantly. They are 117% of market capitalisation and well over the 23.8% average over the last three years. This is a very worrying sign, as managing interest payments on these debts will take priority over the dividend, which explains why the yield is forecast to fall.

This lack of future dividend stability leads me to question whether this truly is a brilliant opportunity or a share best avoided. The low P/E ratio and high yield give the appearance that this could be a great addition to my income portfolio. However, on further inspection, the underlying fundamentals are not strong enough to sustain this high dividend.

Therefore, I am not tempted to add Synthomer to my portfolio as an income-generating investment. The massive dividend is intriguing for the UK share. However, this is too good to be true, especially when the yield is expected to be less than half next year.

The post Is this UK share’s 25% dividend too good to be true? appeared first on The Motley Fool UK.

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Gabriel McKeown has no position in any of the shares mentioned. The Motley Fool UK has recommended Synthomer. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.