Is this 4.8%-yielding penny stock a bargain?

British Pennies on a Pound Note
Image source: Getty Images

In the penny stock universe, finding a company that has been consistently profitable and pays a juicy dividend is not always easy. That is why my attention has been caught by brickmaker Michelmersh (LSE: MBH).

The company made an £8.8m post-tax profit last year on revenues of £68.3m.

That represents a net profit margin of around 13%, which I find attractive. And the business has been consistently profitable for the past few years, including during the pandemic.

It also raised its dividend last year by a whopping 16%.

That means that, at its current penny stock pricing, the dividend yield offered by Michelmersh is 4.8%. That is not one of the highest yields in the sector – rival brickmaker Ibstock yields 6% — but it is still quite decent, in my view.

Attractive valuation

On top of that, the valuation here makes me think that Michelmersh could turn out to be a bargain.

Its market capitalisation is £82m, meaning the business trades on a price-to-earnings ratio of just 8. That seems cheap for a consistently profitably business that has grown revenue sharply in recent years.

However, earnings jumped 44% last year. If they stay at that elevated level, the valuation could be a bargain. If they fall back to their previous level, for example because of weak demand in the newbuild housing market or cost inflation, the valuation may be less of a bargain.

Demand challenges

In May, the company said: “Demand across the construction industry has been impacted by the higher interest rate environment”, adding it was “focused on appropriate portfolio pricing”. That could mean in order to retain volumes it offers more competitive pricing, eating into profitability.

I do see a risk that a weaker housing market – of which there are already clear signs – could hurt demand for bricks.

Set against that, Michelmersh’s premium positioning and broad product portfolio might give it the flexibility needed to respond to market shifts.

Even if the housing market slows, I reckon a shortage of new houses means that a lot of building will still go on. Brick demand may ebb and flow but in the long run I expect it to be high.

As a long-term investor, that attracts me to the idea of adding this penny stock to my portfolio.

My move

On balance, I think Michelmersh could be a bargain for a buy-and-hold investor like me with a long-term outlook.

I like the ongoing profitability, decent dividend and attractive valuation. That already sets the company apart from many penny stocks, in my view.

I am tempted to invest. However, I think I will wait and see how bad things get in the housing market and what impact that has on Michelmersh before making any move.

The post Is this 4.8%-yielding penny stock a bargain? appeared first on The Motley Fool UK.

More reading

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Ibstock Plc. 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 2023