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Many investors like the idea that buying a penny stock could sometimes mean paying a few pennies for something that will turn out to be worth much more in the future.
But penny stocks can be potentially lucrative in other ways, too. Some pay substantial dividends. For example, one I have yields more than 8%. I like that passive income and plan to continue holding the stock, but will the payout continue?
Strong position in the market
The dividend in question hasn't made me go crazy yet, but how much it goes up is something this company knows a lot about.
As the seller of one in five household tiles used nationwide, Topps Tiles (LSE: TPT) has a strong position in the market. After purchasing assets from a competitor that went into liquidation this summer, I think it could be in an even more competitive position.
Long term, I expect demand for tiles to be quite resilient. New houses are built and old ones are rehabilitated.
Still, that doesn't mean Topps is immune to the real estate cycle. In fact, this is one of the key risks I see with this penny stock. After posting a record in terms of revenue for its most recent full year, the group announced this month that its sales revenue in 2024 is likely to be around 6% lower than the previous year.
The company described the business environment as “very challenging all year round”. I think that might still be the case.
Maintaining dividend could be a challenge
Last year the company's dividend was not covered by basic profit. In the interim stage of this year, the dividend remained stable. Again it was not covered. Adjusted earnings per share of 1p did not cover the 1.2p payment. And at the core earnings level, the picture was even worse, with a loss of 1.1 pence per share.
As part of its interim report, the board outlined multiple contingencies it has considered in the event of “a severe but plausible business scenario”. Among other things, it considered suspending the dividend.
For now, I don't think the company's operations deserve a “severe” label. I also think the board will be keen to maintain the dividend if possible. And the adjusted net cash of £19m at the end of the first half gives it some financial cushion.
In my opinion, high performance is helping to support it. If the dividend is cut, let alone eliminated entirely, I think the share price could fall.
Why I still like the investment case
Still, the recent earnings picture hasn't been encouraging. The business environment remains difficult. Unless things improve markedly, I see a real risk that the dividend will not remain at its current level in the coming years.
However, as a long-term investor, I still like Topps' strong position in a market that may see uneven but still continued demand. I have no plans to sell the penny stock.
