Penny stocks can deliver mind-blowing earnings growth and the chance for investors to turbocharge their wealth. However, they also come with higher risk than buying more expensive, larger-cap companies.
These small-cap stocks often trade in low volumes. This means they can be subject to extreme share price swings.
Penny stocks usually have weaker balance sheets than bigger and more mature businesses too. This can hamper their ability to survive tough times. It can also hinder their growth prospects and their ability to pay dividends.
2 cheap penny stocks for income
But there are exceptions to this rule. Many of these small-cap UK shares have long histories of paying decent dividends to their investors.
I dont have a bottomless reserve of cash to draw upon. But here are two income-generating penny stocks I’d buy with a spare £5,000.
#1: Michelmersh Brick Holdings
Rising interest rates pose a threat to Michelmersh’s (LSE: MBH) profits over the short term. In this environment a sharp downturn in the homes market is possible and could smack demand for its bricks.
On the plus side, however, a robust repair, maintenance, and improvement (RMI) market should continue to support sales. Britain’s housing stock is old, and so spending on property restorations remains rock solid.
Michelmersh also operates in other sectors, reducing the threat from the worsening housing market even further. It claimed in September that “our diversification across RMI, housing, commercial, social and specification projects underpins our resilient outlook.”
I like the brickmaker because of its terrific all-round value. It trades on a forward price-to-earnings (P/E) ratio of 8.7 times. And its dividend yields sit at 4.9% and 5% for 2022 and 2023 respectively.
Michelmersh appears in great shape to meet current dividend estimates too. Predicted payouts are covered between 2.4 times and 2.2 times for the next two years.
Any reading above 2 times gives income investors a wide margin of safety.
#2: Topps Tiles Group
Like Michelmersh, Topps Tiles (LSE: TPT) is also vulnerable to a slowdown in Britain’s housing market. This penny stock is also subject to extreme competition from B&Q, Wickes and other major home improvement retailers.
But on the other hand, Topps Tiles should be supported by the country’s resilient RMI sector. Moves to beef up its online proposition this year (via the acquisition of Pro Tiler Tools and launch of Tile Warehouse) should also support trading.
I’m also encouraged by the firm’s expansion into the commercial market through its Parkside division. Sales here continued to meaningfully outperform the market in the last fiscal year (to September 2022).
Topps Tiles is another bargain-basement penny stock in my eyes. It trades on a forward P/E ratio of just 9.2 times. It also sports a chunky 6.4% dividend yield.
Unfortunately dividend coverage here sits at just 1.7 times. But it has a strong balance sheet that should help it meet payout forecasts if earnings disappoint. It had net cash of £15.9m and no debt as of September.
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Royston Wild has no position in any of the shares 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.
Motley Fool UK 2022