One bargain-basement dividend stock I'd buy and one I'd avoid

Updated: 
Topps Tiles

A company paying a decent yield becomes even more tempting when its shares trade on a cheap valuation. That said, income hunters still need to tread carefully. Here's one dividend payer I'd avoid and one I'd buy right now.

Top faller

The last couple of years haven't been particularly kind to holders of Leicester-based retailer Topps Tiles(LSE: TPT) with the shares more than halving in price since they hit a high of 163p back in 2015. Valued at just 10 times earnings and offering a tempting 4.7% yield, is a turnaround on the cards? Based on today's trading update for the full year (ending 3 October), I'm not convinced.

At £211.6m, revenues will be slightly below those achieved in 2016, with like-for-like-revenues also expected to be down almost 3% compared to the 4.2% rise witnessed 12 months ago. As a result of trade worsening over H2, Topps now expects adjusted pre-tax profits to come in at the lower end of the range of market expectations.

It's not all bad news. The firm stated that it was making "goodprogress" at strengthening its market-leading position while keeping a tight rein on costs over the year. Customer service ratings were "at record levels" over the period and the ongoing focus on building its in-house range meant that 83% of the tiles it sells were now exclusive to Topps. The company's loyalty scheme -- established 12 months ago -- now has 55,000 traders registered.

Nevertheless, it seems fairly likely that Topps could face increased headwinds if economic uncertainty persists and consumers cut back on home improvements. Indeed, CEO Matthew Williams commented that the company would be taking a "prudent view" on market conditions over the next financial year. The not-insignificant amount of debt on the company's books relative to net profit shouldn't be overlooked either.

With shares falling almost 5% in early trading this morning, it appears the market thinks things could get even tougher for the small-cap.

Far from rubbish

The best investments are often far from beautiful. Despite the rather unpleasant nature of its business, I think £585m cap waste manager Biffa(LSE: BIFF) is a far better income play.

Since coming to the market almost one year ago, the company's shares have performed admirably, rising 31% to now change hands at 234p. Importantly, the debt burden that made me initially wary of the stock has come down markedly. What's more, the company is expected to post a return to profit in the current financial year.

September's pre-close trading update made reference to solid organic and acquisition revenue growth over the six months to the end of September. In July, the Wycombe-based business purchased O'Brien Waste Recycling Solutions for just over £35m and is "actively exploring" more opportunities. Tellingly (and in complete contrast to those in charge at Topps Tiles), Biffa's Board "remains confident" in the company's outlook for the full year.

At 3%, Biffa's forecast yield for the year may be a lot less than that offered by the tile specialist. Nevertheless, the fact that payouts are covered 2.6 times by expected profits suggests there's a lot of scope to increase dividends moving forward. Moreover, the non-cyclical nature of waste management makes it a fairly defensive pick in the prevailing economic and political climate.

Trading on less than 13 times 2017 earnings, Biffa looks a diamond in the rough.

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Paul Summers 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.