2 dirt-cheap dividend stocks that could make you brilliantly rich

Roland Head highlights two high-yield stocks that have issued strong trading updates.

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Sometimes you’ve just got to be patient with stocks. After drifting lower all summer, shares of educational software and services group RM (LSE: RM) rose by 15% in the opening hour of trading this morning.

The group now says its full-year results should be “ahead of expectations”. Although management hasn’t see fit to provide any figures for guidance, I’d expect this to mean that earnings are likely to be 5%-10% higher than consensus forecasts.

If that’s the case, then RM could report adjusted earnings of about 20p per share this year. At the last-seen price of 185p, that would still leave the stock on a modest forecast P/E of 9.3.

Should you rush in and buy?

RM’s last move higher came in February, when it announced the acquisition of Connect Group‘s educational business. This £56.5m deal was quite significant for the group, as the Connect business appeared to have the potential to add around 40% to full-year sales.

The integration of this business appears to be going well. RM said today that expected cost savings are likely to be greater than the £2m originally expected. Trading is also said to have been solid across the group’s other businesses.

Looking ahead

Analysts expect earnings to rise to 21.5p per share in 2018/19, as the full benefits of the Connect acquisition flow through to the bottom line. This puts RM stock on a modest forecast P/E of 8.6, with a prospective dividend yield of 4.4%. I’d continue to rate this stock as an income buy following today’s news.

A 7% yield I trust

A dividend yield of 7.9% without full earnings cover would normally be a cause for alarm, signalling a likely dividend cut. But before dismissing companies with high yields, it’s often work taking a look at the figures.

Just occasionally, these generous payouts can be affordable. In my view, payment processing group PayPoint (LSE: PAY) is a good example of this.

The firm’s recent half-year results showed that profits remained stable during the first half, despite a slight fall in revenue. Underlying operating profit was broadly flat at £24.4m, while operating cash flow — crucial to dividends — rose by 5.3% to £29.5m.

This business has always generated a lot of surplus cash, and these figures suggest to me that this attraction remains.

Although the group’s forecast full-year dividend of 71.4p per share isn’t covered by expected earnings of 62p per share, I expect most of this payout to be covered by free cash flow. The remainder will be funded from the group’s net cash balance of £27.6m, which is gradually being returned to shareholders.

A pure income buy?

The outlook for growth here looks limited. But PayPoint handles a wide range of payments through its corner shop terminals, and in my view this business is likely to have a stable future.

The stock currently offers a forecast yield of 7.8%, rising to 8% for the 2018/19 financial year. As the group’s cash balance falls, these payouts may eventually be cut so that they’re covered by earnings. But even then, I’d expect a yield of around 5%.

I believe this stock has the potential to deliver a 20% cash return in three years. I’d rate the shares as an income buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of RM. The Motley Fool UK owns shares of 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.

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