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These two hated dividend stocks are buys to me

Image: PayPoint. Fair use.

Paypoint (LSE: PAY) and Xaar (LSE: XAR) are two top dividend stocks. Unfortunately, these stocks are also two of London’s most disliked dividend stocks for multiple reasons.

Over the past year shares in Paypoint have fallen by 1.5% excluding dividends, while shares in Xaar have declined by a staggering 20.5%. Over the same period, the FTSE 100 has added 22.4% so you might have been better off buying a FTSE 100 tracker fund than either of these market laggards.

However, when it comes to income, both Xaar and Paypoint offer much more than a simple FTSE 100 tracker.

Dividend champions

After recent gains, at the time of writing the FTSE 100 supports a dividend yield of just under 3.7%. Even with the lowest-cost tracker fund on the market, investors would receive less than 3.5% per annum in income by investing in the UK’s leading index.

Shares in Paypoint on the other hand, currently support a dividend yield of 4.4% and City analysts expect this to rise to 5.1% as management looks to increase the company’s dividend payout towards the end of the financial year.

Investors have moved away from Paypoint in recent months because the company is struggling to grow in the UK’s increasingly competitive payments market. After growing earnings per share from 45.7p for the financial year ending 31 March 2013, to 64.3p for the year ending 31 March 2017, City analysts expect earnings per share to fall by 4% for this financial year. As the company is currently trading at a forward P/E of 15.6, falling profits are a cause for concern.

Still, Paypoint’s dividend remains well covered by earnings per share and the company is highly cash generative with few capital spending obligations. Fiscal 2018’s payout is expected to be covered 1.3 times by earnings per share, and for the past five years the company has generated £17.6m and excess cash after capital spending and dividend payments.

Falling earnings

Xaar is another company that’s suffering from declining profits, but investors seem to be overlooking the firm’s dividend potential. Earnings per share slumped from a high of 44.9p in 2013 to an expected low of 13p for 2017. However, City analysts expect earnings to rebound by 38% to 18p next year, and a dividend payout of 11.3p per share has been pencilled-in for this period.

This estimated payout means Xaar’s shares support a forward dividend yield of 3.1%, which is below the market average, but there’s plenty of room for further payout growth. Like Paypoint, Xaar is swimming in cash having issued no debt during the past five years and generating £37m in cash from operations after capital spending and dividend payments. As a result, when earnings stabilise, I wouldn’t rule out a substantial dividend increase or special payout.

The one downside about Xaar is that the company’s shares look relatively expensive compared to its earnings growth (or lack of it). Shares in the company currently trade at a forward P/E of 25.3, which may be unpalatable for some value investors.

Dividends: The fastest way to a million

Dividends are essential for building wealth over the long term. Indeed, dividends have the potential to more than double your returns through the miracle of compounding. As a result, they can significantly increase your chances of being able to retire early and achieve financial independence.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool owns shares in Paypoint. 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.