One of my investment objectives for 2023 is to generate additional passive income. When my financial circumstances allow, I therefore intend using my ISA to buy more high-quality dividend stocks.
I consider Lloyds Banking Group (LSE:LLOY) to be one of the best. But there’s another British income stock that has just come onto my radar, so it’s worth me comparing the two.
A dark horse
For its 2022 financial year, the bank declared a dividend of 2.4p per share. This year I expect an increase of 12.5% to 2.7p. If my forecast is correct — and I were to use all of my £20,000 ISA contribution limit to purchase 40,000 shares – I could earn £1,080 in passive income. This would give a yield of 5.4%.
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As Britain’s biggest mortgage lender, the fortunes of the bank are closely aligned to the domestic property market. Recent increases in interest rates have made mortgages more expensive. But last week the International Monetary Fund predicted that rates in major economies will fall back to pre-pandemic levels once inflation has been squeezed out of the system.
This could be a mixed blessing for Lloyds. The upside from an increase in the demand for mortgages may be offset by a reduction in its net interest margin. But the risk of bad loans will recede and I’m confident that the bank will be able to maintain its above-average payouts.
However, I already own shares in Lloyds. For a risk-averse investor like me, diversification is important. I therefore don’t want to buy more shares in the bank.
Another idea
However, I recently came across a stock that’s presently offering a better yield.
Purchasing 40,000 shares in Topps Tiles (LSE:TPT) would also cost me £20,000. Assuming last year’s dividend remained unchanged, I could earn £1,440 in passive income in 2023.
However, the company has recently revised its capital allocation policy. The new plan involves increasing the dividend to 67% of earnings per share (EPS) over the next two years.
If the directors achieve this — and assuming the firm’s EPS remains unchanged at 6.14p — a shareholding of 40,000 shares would generate £1,644 in dividends in 2025. This implies a yield of 8.2%.
Top of the shops
Like most, the company suffered during the pandemic. But revenue is now higher than pre-Covid and the company is profitable once more.
| Metric/financial year | 28.9.19 | 26.9.20 | 2.10.21 | 1.10.22 |
| Revenue (£m) | 219.2 | 192.9 | 228.0 | 247.2 |
| Profit/(loss) before tax (£m) | 12.5 | (9.8) | 14.0 | 11.0 |
The company operates 304 shops in the UK. Despite having a significant online presence, the company claims that 98% of its sales involve a visit to a store.
But its market cap is currently 350 times smaller than Lloyds. This means it’s less able to cope with an unexpected downturn in business. However, it does have an unused £30m bank facility available to provide a safety net, or help fund its future expansion.
One area of concern is the declining margin. Last year it reported a 54.8% gross profit margin. Three years earlier it was 61.6%. This might not sound like much of a deterioration but it cost the company nearly £17m in 2022.
However, the company is cash generative, debt-free and the market leader in its sector. It should therefore be in a position to give me more passive income that I’d get from an equivalent stake in Lloyds.
When funds permit, I’m going to consider investing in Topps Tiles.
