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Why I’d avoid this dividend stock and buy this 9% yielder instead

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At first glance, Topps Tiles (LSE: TPT) looks to be a great income investment. Indeed, according to current City forecasts, the shares support a dividend yield of 4.3%, and the payout is covered twice by earnings per share. 

However, as today’s trading update from the firm shows, Topps’ outlook is not as clear as it once was. Like its peers across the retail sector, Topps is struggling to grow in the increasingly competitive UK retail market. According to today’s update, like-for-like sales in its fiscal second quarter slumped by 2.2%, dragging growth down to just 0.6% for the 28-week period ending 31 March. Even though this reported figure is slightly better than last year’s sales contraction of 1.9%, management is expecting things to get worse before they get better. 

Further pain ahead

Commenting on today’s sales figures, CEO Matthew Williams said: “After a strong start to the year, market conditions have become more challenging over the second quarter.” And while the group has performed better than the wider tile market so far, management is “retaining a cautious view of market conditions for the remainder of the year.” 

Based on this outlook, it would appear that Topps is going to struggle to grow in 2018, something analysts had already been expecting. It is also now possible that the firm’s earnings might contract for the second year in a row, putting pressure on management to take drastic action to rekindle growth. 

With this being the case, no matter how attractive the dividend yield and lowly valuation of 11.3 times forward earnings seems, I would avoid the stock. 

If you are looking for income, a better buy might be 9% yielder Galliford Try (LSE: GFRD). Based on current City estimates, shares in Galliford support a dividend yield of 9.4% and trade at a forward P/E of 5.2. Unfortunately, the high yield comes with a degree of uncertainty. 

Getting worse before it gets better

In February the company announced that it was cutting its interim dividend from 32p to 28p per share and issuing £150m worth of new shares to cover liabilities stemming from the collapse of outsourcer Carillion. As my Foolish colleague Roland Head pointed out at the time of the fundraising, due to the higher number of shares in issue, and management’s target to maintain dividend cover at two times adjusted earnings, this could mean Galliford’s annual distribution falls to 67p per share for 2018, giving a potential dividend yield of 8.2%. 

While a full-year dividend cut is disappointing, a yield of 8.2% is nothing to be sniffed at. It is still more than double the FTSE 100 average. What’s more, according to my figures it won’t be long before the payout starts growing again.

After taking a step back in 2018, City analysts are expecting earnings per share to return to growth in 2019, hitting 162p. A 50% payout ratio implies a dividend of 81p per share based on this figure, giving a potential forward dividend yield of 9.8% on today’s share price of 818p.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.