5 Small-Caps with More Than 10 Years of Dividend Growth

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Investing in small-cap stocks can be rewarding. History shows that small-cap stocks provide better risk-adjusted returns than broader-market portfolios. When one adds dividends to the mix, small-cap dividend stocks can provide current income that magnifies total returns. Investors in small-cap dividend stocks should look for companies with sustainable payouts, proven history of dividend growth, solid balance sheets, and strong profitability.

Russell Investments has devised a specific small-cap-focused index, the Russell 2000 Dividend Achievers Index, which, based on the Mergent’s Dividend Achievers methodology, tracks liquid stocks of companies with ten or more consecutive years of dividend growth, the main criteria aside from firm size for inclusion in the index. The Index consists of 63 securities, most of which constitute good investments for investors looking for capital growth and current income. Here is a list of five small-cap Russell 2000 Dividend Achievers with yields above 2% that were randomly selected from several different industries represented by index constituents. The yields of the selected stocks exceed the average yields on the 10-Year Treasuries of 1.78%, the Russell 2000 Index of 1.92%, and the S&P 500 Index of 2.21%.

Watsco Inc. (NYSE: WSO) is a $2.4-billion distributor of air conditioning, heating, and refrigeration equipment. The company’s dividend yields 3.3% on a payout ratio of 82% of trailing earnings and 45% of trailing free cash flow. Watsco’s dividend grew, on average, by 18.6% annually over the past five years. Analysts forecast the company’s 5-year EPS CAGR at almost 17%, which reverses the trend of negative growth, on average, over the past five years.

The company is optimistic about its long-term growth prospects, given the recovery in U.S. housing and the potentially large replacement demand for air conditioners and heating systems in the U.S. In addition to a solid balance sheet, this company has a free cash flow yield of 3.4% and an ROE of 11%. Its forward P/E is 21.5x, above its competitor Lenox International’s 16.5x but below Comfort System USA’s 30.9x. In October, Watsco paid a $5 per share special dividend. The company has paid dividends for 35 years and has raised them for 11 consecutive years.  Small-cap value investor Chuck Royce holds a position in this stock.

New Jersey Resources Corp. (NYSE: NJR) is a $1.7-billion company that provides retail and wholesale energy services to customers in the United States. Its operating segments include gas distribution, energy services, and midstream assets. The company has paid dividends since its inception in 1953 and has raised them for the past 16 years. Its dividend yield is 4.0% on a payout ratio of 72%. NJR’s dividend growth over the past five years averaged 8.7% annually. The company’s 5-year EPS CAGR is forecast at about 4.0%. Steady customer growth and infrastructure investments are the main growth drivers. The stock is priced below the gas distribution industry. Its forward P/E is 16.2x versus 18.2x for its industry on average. The stock has an ROE of 12%. Among fund managers, Citadel Investment’s Ken Griffin has a small stake in the company.

Owens & Minor Inc. (NYSE: OMI) is a $1.8-billion supplier of healthcare products and third-party logistics and supply-chain management services. Currently, its dividend yields 3.1% on a payout ratio of 51%. The company has paid dividends each year since 1926 and has raised them for the past 14 years in a row. Its dividend grew, on average, by 14.2% per year over the past five years. Analysts forecast the company’s 5-year EPS CAGR at 7.8%.

Even though the company operates in a highly competitive environment, it has been able to generate strong growth. Owens & Minor has gained market presence in Europe through Movianto acquisitions that closed in August 2012. Analysts estimate that the company’s future growth will be driven by tuck-in acquisitions and innovative solutions. Owens & Minor sees its revenue growing in 2013 by between 2% and 4%. The stock has attractive valuation. Its forward P/E of 15.7x is below its industry average ratio of 17.2x. Moreover, its price-to-book of 1.9 is well under the industry’s 2.8.  Owens & Minor is popular with small-cap value investors Chuck Royce and David Dreman.

Tanger Factory Outlet Centers (NYSE: SKT) is a $3.1-billion REIT that owns and operates outlet shopping centers. This REIT has paid cash distributions since 1993 and has raised them each successive year. Tanger Factory Outlet Centers’ cash distribution is currently yielding 2.5% with distribution coverage of 52% of funds from operations [FFO]. Over the past five years, its distributions grew, on average, by 3.2% annually. This year, the company hiked its distribution by a larger-than-average 5.0%.

Jefferies analysts forecast this REIT’s FFO per share will grow 14% in 2013 and 9% in 2014. This compares to mall REITs and shopping centers’ 2013 FFO growth of 8.6% and 5.6%, respectively. The outlook is upbeat on continued resilience of the U.S. consumer—a condition that should improve with faster job growth—and an increased appeal of value shopping. This REIT is valued at 18.3x 2013-estimated FFO, compared to CBL & Associates Properties’ 10.0x and Simon Property Group’s 20.0x. Fund manager Ken Heebner (Capital Growth Management) initiated a new position in the stock in the third quarter. 

Lancaster Colony Corporation (NASDAQ: LANC) is a $1.9-billion company that sells specialty foods like salad dressings and fruit dips, as well as glassware and candles. The company has raised dividends each year for the last five decades. Its dividend is yielding 2.2% on a payout ratio of 41%. The food producer grew its dividends, on average, by 5.7% annually over the past five years. For the next five years, the company’s EPS CAGR is forecast to average 10%.

The company’s bottom line is benefiting from stronger pricing of its specialty foods and easing commodity cost pressures. The company’s balance sheet is solid, as it has no long-term debt. Its free cash flow yield is 3.4% and ROE is 18%. With a forward P/E of 16.9x, the stock is trading almost on par with its respective industry (forward P/E of 16.7x). The company also has a below-industry price-to-book ratio. Lancaster Colony will pay a $5 per share special dividend on Dec. 28, 2013. Chuck Royce holds 1.27 million shares of this stock. 

This article is written by Serkan Unal and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Watsco. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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