This hugely profitable 7.2%-yielding FTSE 250 stock looks great on paper! But there’s a catch
One of the attractions of the FTSE 250 is its mix of familiar names and hidden gems. These mid-cap firms donât always have the global reach of FTSE 100 giants, but their domestic exposure can help limit risks from currency swings. Smaller market-caps can also mean more room for growth.
That said, the trade-off is often volatility, which makes it vital to look carefully at dividend policies, payout ratios and long-term profitability.
When it comes to dividends, many investors prefer a history of consistent payments backed by strong financials. A high yield can look tempting, but without reliable earnings, it may not be sustainable. And that brings me to one lesser-known mid-cap company that caught my attention this week.
Dunelmâs impressive numbers
Dunelm Group‘s (LSE: DNLM) a well-known homewares retailer, selling everything from bedding and bathroom wares to rugs, curtains and furniture. It operates through physical stores, catalogues and its growing online presence. The companyâs dividend yield is an eye-catching 7.2%, among the top 30 on the index.
The number that really jumps off the page though, is return on equity (ROE). At 121.78%, Dunelm boasts the highest figure across the entire FTSE 250. ROE measures how effectively a company generates profit from shareholdersâ equity and, at first glance, this suggests the business is incredibly profitable.
Combined with a dividend track record that includes five years of uninterrupted payments and two consecutive years of growth, Dunelm certainly looks worth considering.
But as always, I think itâs important to dig beneath the surface.
The risks behind the rewards
While Dunelmâs ROE figure’s impressive, it doesnât tell the full story. The companyâs net margin is just 8.83%, and its free cash flow margin stands at 12.28%. These arenât disastrous numbers, but they donât suggest a business overflowing with profitability either.
More concerning is the dividend payout ratio, which is slightly above 100%. That means dividends arenât fully covered by earnings, raising questions about sustainability if profits donât keep up.
Then thereâs the matter of debt. Dunelm has £377.7m in total debt compared with just £118m in equity. That imbalance is significant. Revenue and earnings are forecast to rise modestly in 2026, but thereâs no certainty that those expectations will be met.
If equity weakens further, the company could find itself under pressure to service its obligations. And that raises the real risk of a dividend cut.
In fact, I canât help but think that Dunelmâs huge ROE figure may be flattered by its financial leverage. High debt levels can artificially boost ROE, making a business look more profitable than it truly is. But if earnings stumble, leverage works in reverse â magnifying losses and potentially putting the balance sheet under serious strain.
My verdict
Dunelm has an attractive yield, a recognisable brand and a dividend history that income investors might find encouraging. But with dividends not fully covered and debt levels sitting uncomfortably high, I think itâs one that investors need to weigh up very carefully.
For those willing to consider risk, Dunelm could still find a place in a diversified dividend portfolio. But without stronger earnings growth, its financial leverage may prove more of a burden than a benefit.
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Mark Hartley has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
