As the FTSE 100 nears record levels, yields fall, valuations stretch and quality income stocks become harder to find. But while large-cap shares dominate headlines, the lesser-travelled world of penny stocks could be harbouring some surprising income potential.
Penny stocks are often disregarded due to their speculative nature. They can be illiquid, volatile and lack reliable financials. Many are small-cap growth stories without a history of profitability, let alone dividends.
But amid the noise, there are a few gems that stand out as possible exceptions. One such company is Ultimate Products (LSE: ULTP).
A simple business
Ultimate sells everyday household items under well-known brand names such as Salter, Beldray and Kleeneze. The firm operates in a highly competitive segment but its niche in affordable kitchen and cleaning products has allowed it to build steady customer demand across the UK and Europe.
What makes it worth considering in today’s income-starved market is its generous 8.3% dividend yield. Unlike most penny shares, which pay no income at all, Ultimate has delivered eight consecutive years of payouts. The dividend appears sustainable too, with a payout ratio of 78%, suggesting enough earnings are being retained to keep the lights on.
On valuation, the stock appears attractive. With a price-to-earnings (P/E) ratio of just 9.5 and a price-to-sales ratio of 0.44, it looks to be trading well below the market average. By comparison, many large-cap FTSE 100 names now look fully priced after a strong rally this year.
Penny risks
Naturally, there are still some red flags investors shouldn’t ignore. Despite its reliable dividends, the share price has climbed just 17% over the past five years. This underperformance is partly due to thin operating margins (4.67%) and strained cash flow, with just £1.6m in operating cash generated. In a low-margin retail environment, rising input costs or supply chain issues could easily eat into profits and threaten future payouts.
There’s also the ever-present issue of liquidity. The company’s shares are lightly traded, and its £64m market-cap places it firmly in the micro-cap territory. That brings additional risk during market downturns, when small-caps tend to be hit hardest and recover last. For those depending on steady income, volatility like this can be unsettling.
A diverse play
Risks aside, the stock could appeal to long-term investors seeking something other than the usual fare. With larger dividend payers offering yields closer to 5% today, an 8.3% yield from a profitable, dividend-paying penny stock sounds appealing — if you can stomach the risks.
Overall, I think it’s worth considering, but diversification remains crucial. Ultimate could help raise the average yield of a portfolio primarily made up of more stable but lower-yielding FTSE 100 shares. And by spreading investments across different sectors, company sizes and risk profiles, investors can mitigate the impact of any single stock underperforming or cutting its dividend.
As always, these types of penny stocks won’t go well with everyone’s risk appetite. But in an environment where the big names are looking increasingly expensive, they might just offer a small corner of hidden value for those willing to look beneath the surface.
