When it comes to investing, value is not just about price. Simply because a share sells for pennies does not necessarily make it a bargain. But this week, I bought one penny share that combines a proven, profitable business with juicy passive income prospects.
Moneymaking company
The share in question is Topps Tiles (LSE: TPT).
Topps is a well-known building supplies provider that has been around for six decades. It has long since proven it can make money by shifting tiles.
Last year, revenues grew 8% to almost a quarter of a billion pounds. Pre-tax profits shrank, but still came in close to £11m. Basic earnings per share of 4.6p means this penny share currently trades on a price-to-earnings ratio of around 11, using last year’s figures.
This year has started less promisingly for Topps. In the first half, although revenues grew 9%, pre-tax profit was down 70% compared to the same period last year.
Despite that, the company reckons a strong second half will help it deliver in line with average market expectations of £11.5m in adjusted profit before tax.
Long-term outlook
But it is not just the short term I consider when investing. Although it has penny share status, I think Topps has the makings of a solid long-term performer.
It has a large network of sites, a deep customer base of trade buyers, and has been investing in its online presence through channels such as Pro Tiler Tools.
The company ended its first half with almost £20m in net cash. That likely means it can continue to raise its dividend in the medium term, even if financial performance is erratic. The interim dividend was boosted 20%, for example, although that was not covered by basic earnings.
Ultimately, to grow dividends, the business will need to deliver strong financial performance. One risk is a weak economy hurting demand. Another is inflation squeezing profit margins at the group.
While these are risks, I think they also help explain why Topps continue to trade as a penny share. I see such risks as priced in already. Longer term, I expect strong demand and inflation to revert to historical norms.
I’ve bought
That is why I decided to add Topps Tiles to my portfolio this week.
I am optimistic it offers me the prospect of long-term capital growth. Meanwhile, the dividend yield is already attractive and I reckon there is scope for further growth in the payout.
Dividends are never guaranteed though. And given the uncertainty surrounding what will happen in the housing market, I do not expect the coming years to be smooth sailing for Topps.
But thinking about the years not just months to come, I think Topps’ expertise and strong market position set it apart from competitors.
