A profitable penny stock with a well-covered 8% dividend yield! What’s the catch?

Penny stocks are often tempting because they appear cheap and can offer explosive growth potential. But they come with significant downsides too. Many are unproven, lack consistent earnings, and rarely pay dividends.

On top of that, their tiny market-caps can lead to sharp price swings and thin liquidity. This can be risky as it makes them more difficult to sell quickly in a downturn. That’s why it’s crucial to do proper due diligence when fishing in these small-cap waters.

I recently came across a penny stock that bucks many of these typical trends. In fact, it looks like it could be a lucrative income opportunity. That company is Alternative Income REIT (LSE: AIRE).

A lesser-known property stock

As the name suggests, Alternative Income REIT invests in commercial property assets, aiming to generate steady rental income for shareholders. Its portfolio’s diversified across sectors including industrial, retail warehousing, leisure and logistics. That gives it a spread of tenants and long leases — an attractive trait for income-focused investors.

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Financially, the £60m business seems to be on firm footing. Currently trading at around 75p, the share price is up a modest 49% over the past five years. Revenue’s crept up 4% year on year, but what really caught my eye was the steep 88% diluted earnings growth. This suggests the company has been successfully tightening costs or renegotiating lease deals to improve profitability.

The valuation also looks decent by REIT standards. Its price-to-earnings (P/E) ratio stands at 11.9, which is comfortably below the broader market average. Meanwhile, its price-to-book (P/B) ratio is just 0.92 — indicating the shares are trading at a slight discount to the value of the underlying property assets.

Strong income potential… with risks

It’s the dividend profile that really sets this penny stock apart. Alternative Income REIT currently pays 6p per share, which equates to an impressive 8.15% dividend yield. The payout ratio’s 96.9%, which is high, but that’s typical for REITs — they’re legally obliged to distribute the majority of rental profits to shareholders.

Importantly, it’s been paying dividends consistently for the past seven years. For a penny stock, that’s a decent track record of delivering cash back to investors.

Of course, there’s always a catch. As a micro-cap, Alternative Income REIT remains vulnerable to market volatility and low trading volumes, which could amplify in any downturn. Being in commercial property, it’s also sensitive to economic slowdowns and changes in tenant demand. And with a small portfolio compared to larger real estate giants, losing a key tenant or facing unexpected vacancies could significantly hurt its rental income.

Even so, for investors seeking exposure to real estate with a chunky yield, this penny stock looks unusually attractive. As said, REITs are generally bound by regulations that ensure profits flow back to shareholders, and Alternative Income REIT appears to be executing well on that front.

For my part, I wouldn’t bet the house on it — but as part of a diversified income portfolio, it looks like a penny stock worth considering.

The post A profitable penny stock with a well-covered 8% dividend yield! What’s the catch? appeared first on The Motley Fool UK.

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Mark Hartley 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.