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Should income investors buy this 6% yielding tech stock?

The share price of information technology services and solutions provider Data#3 Limited (ASX: DTL) has risen 4.1% to $1.52 following last Wednesday’s trading update at the company’s AGM.

Data#3 announced that it expects first-half pre-tax profit for FY19 to be in the range of $7.0 million to $8.5 million, a significant improvement over the $4.0 million in pre-tax profit the company delivered in the first half of FY18. However, it should be noted that the guidance provided by the company is roughly in line with the $8.1 million of pre-tax profit it generated in the first half of FY17.

FY18 was a difficult year for Data#3 with its full-year earnings and dividend both declining due to a number of operational issues. Despite group revenue rising by 7.6% to $1.2 billion, pre-tax profit fell by 8.9% to $20.4 million. As a result, the company’s total dividend was cut from 8.9 cents a share to 8.2 cents a share.

The decline in earnings was attributed to lower than expected contributions from the acquisitions of Business Aspect and Discovery Technology, which was not offset by the growth in the company’s core businesses.

Business Aspect recovered from its first-half loss to finish close to breakeven, but this was still below its FY17 performance. Discovery Technology’s pre-tax profit, on the other hand, declined by $1.7 million, which was largely due to the early termination of a 5-year supply contract.

Foolish takeaway

At current prices, shares of Data#3 are trading for around 15 times the consensus earnings per share estimate of 10.35 cents for FY19. The business is historically lumpy in terms of earnings skew that makes forecasting difficult. If the company hits the consensus target, this would represent earnings per share growth of around 13% over FY18’s 9.14 cents.

Data#3 pays out the majority of its earnings with a dividend payout ratio of 89.7% in FY18. With that in mind, investors could expect to receive a fully franked dividend of around 9 cents that comes attached with full franking credits.

At 15 times forward earnings and with a dividend yield of approximately 6%, Data#3 looks like a reasonably solid investment for income-oriented investors comfortable with exposure in the small-cap space. I would also rate Data#3 above other small-cap IT stocks such as DWS Ltd (ASX: DWS) and RXP Services Ltd (ASX: RXP) that have also struggled in 2018.

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Motley Fool contributor Tim Katavic has no financial interest in any company mentioned. The Motley Fool Australia has recommended Data#3 Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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