A lot of investors like the idea that buying a penny share could sometimes mean paying pennies for something that turns out to be worth a lot more in future.
But penny shares can be potentially lucrative in other ways too. Some pay substantial dividends. For example, one I own yields over 8%. I like that passive income and plan to keep holding the share – but will the payout continue?
Strong market position
The dividend in question has not yet sent me up the wall, but what goes up walls is something this company knows a fair bit about.
As the seller of one in five household tiles used across the country, Topps Tiles (LSE: TPT) has a strong position in the market. After it bought assets from a competitor that entered liquidation this summer, I think it could be even more competitively positioned.
Over the long term, I expect demand for tiles to be fairly resilient. New houses are being built and old ones refurbished.
Still, that does not mean Topps is immune to the housing cycle. Indeed, this is one of the key risks I see with this penny share. After reporting a record in terms of revenue for its most recent full year, the group announced this month that its 2024 sales revenues are likely to be around 6% lower than the previous year.
The company described the trading environment as “very challenging across the whole year”. I think that could continue to be the case.
Maintaining the dividend could be challenging
Last year, the company’s dividend was not covered by basic earnings. At the interim stage this year, the dividend was held flat. Again it was not covered. Adjusted earnings per share of 1p did not cover the 1.2p payout. And at the basic earnings level, the picture was even worse, with a loss of 1.1p per share.
As part of its interim report, the board outlined multiple contingencies it has considered in the event of “a severe but plausible trading scenario”. Among others, it considered suspending the dividend.
For now, I do not think the company’s trading merits a “severe” label. I also think the board will be keen to maintain the dividend if it possibly can. And adjusted net cash of £19m at the end of the first half gives it some financial cushion.
The high yield is helping support it, in my view. If the dividend is cut, let alone axed altogether, I think the share price could tumble.
Why I still like the investment case
Still, the recent earnings picture has not been encouraging. The trading environment remains difficult. Unless things improve markedly, I see a real risk that the dividend will not be sustained at its current level in coming years.
As a long-term investor though, I continue to like Topps’ strong position in a market that may see uneven but still ongoing demand. I have no plans to sell the penny share.
This post was originally published on Motley Fool
