Small Cap Dividend Growers

08 Mar 2015 21:43
Tags bhb mhld micro_cap small_cap span tess weys

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Without a doubt, the rock stars of dividend growth are large cap and mid-cap companies like Procter & Gamble, Johnson & Johnson, 3M, and Coca-Cola. It is for good reasons they get top billing and are investing darlings. They are well known names, with conservative financials, strong well positioned products and have been growing dividends for decades.

But large companies are not the only source for dividend growers. Small & micro-cap companies also have their growers and there are advantages and disadvantages of having them in your portfolio.

Advantages

  • Small company stocks typically are thinly traded and are not subjected to wild price swings during market corrections or run-ups, this is reflected in their low beta. This low beta can help add some stability to your portfolio during these times.
  • Small companies with strong management and conservative financials tend to operate and at times dominate their local market or niche service. In other words, they have a strong moat locally instead of nationally.
  • Conservatively run small companies typically do not have a strong future for massive equity returns in their stock price. Instead they focus more on how to return value to shareholders and it is not uncommon to see the “Special Dividends” issued every so often.

Disadvantages

  • Being small usually translates into a small customer base. Some companies may have 20 to 40% of earnings from a single customer. If that single customer leaves the effects would be devastating.
  • Some small businesses are tied to the local economy and not the national economy. While the rest of the economy may be booming your local might be collapsing. Detroit is an excellent example of a failing local economy in relation to a recovering national economy.
  • Their niche market may be seasonal or cyclical so you have stomach earning swings. Snow removal equipment is a good example.
  • If they are thinly traded and you have too large of a position you may not be able to effectively sell all of your shares in a single transaction.

My favorites

Due to the disadvantages identified above, I would not make small companies a significant percentage of my portfolio but I would allocate 10% to 15%. Is this the correct allocation amount? I am not sure as I will have to back test a model for the right % mix. But regardless, here are my 2015 favorites of which I personally own two (BHB & MHLD).

Bar Harbor Bank (BHB)

Dividend Yield 3.44%
5yr CAGR 5.5%
Yrs of Dividend Growth 12
Market Cap $194M
Beta 0.68

Bar Harbor is a local Maine bank with 15 branches, a well-managed balance sheet and has been around since 1887. They review dividend payouts quarterly and have had 15 straight quarters of dividend growth.

Besides a strong financial statement and dividend growth record, what I really appreciate, and see as their biggest strength, is the board of directors. All of the directors are local business (or former) owners. The businesses they represent are varied from Real Estate, to Funeral Homes, to Car Dealerships. Essentially the board members have such connections with the local community and economy that they understand the pulse of Maine's economy and as such make decisions to guide the bank to consistent profitability.

Maiden Holdings (MHLD)

Dividend Yield 3.7%
5yr CAGR 14.96%
Yrs of Dividend Growth 7
Market Cap $1.03BM
Beta 0.84

MHLD is an insurance company based in Bermuda that provides reinsurance solutions to regional and specialty insurers primarily in the United States and Europe. It operates in three segments: Diversified Reinsurance, AmTrust Quota Share Reinsurance, and ACAC Quota Share.

What I really like about this company is their continued focus on growing earnings and being extremely shareholder friendly. MHLD is a re-insurer and what usually makes me nervous with insurance companies is their ability to execute risk management and how or where they keep their investments.

MHLD has been implementing a strategy to exit high risk segments and entering predictable and stable operating segments. This strategy has paid off over the last three years as we have seen earning grow from $0.39 per share in 2011 to $1.53 per share in 2014.

In regards to investments, it is fairly common for insurance companies to invest in fixed income and MHLD is no different. The concern here is when interest rates rise bond prices will fall creating a potential loss. Fortunately, for MHLD, most of their fixed income bonds have a maturity of less than 10 years and only 2.2% of their bonds have a maturity greater than 10 years so if rates do rise losses will be minimal.

Span-America Medical Systems (SPAN)

Dividend Yield 3.16%
5yr CAGR 9.4%
Yrs of Dividend Growth 16
Market Cap $56M
Beta 0.02

Span-America Medical Systems manufactures and distributes various therapeutic support surfaces and related products for the medical, consumer, and industrial markets. It operates through two segments, Medical and Custom Products.

SPAN is nice entry into the healthcare field as its products can be found in hospitals, nursing homes, rehabilitation centers, convalescence homes, medical centers and specialized bedding for homes.

But the biggest drawback for SPAN is its size. With a market cap of $56M and just under 3M outstanding shares this is as far as you can get from a highly traded stock with an average daily trade volume of only 5600.

Tessco Technologies (TESS)

Dividend Yield 3.67%
5yr CAGR 43.1%
Yrs of Dividend Growth 6
Market Cap $178M
Beta 0.54

Tessco Technologies architects and delivers products and value chain solutions to organizations for building, operating, and maintaining wireless broadband systems.

Tessco is currently a mild turnaround story. TESS was a victim of having a large percentage of revenue coming from one customer and in this case AT&T. When AT&T parted ways with TESS revenue dropped from $752M in 2013 to $560M in 2014 or a 25% decrease. Investors took this news negatively and sent the stock plummeting from its high of $41.77 per share to its current price of just $21.78.

Unfortunately, investors took the AT&T loss and didn't look closer at the numbers. Business with AT&T had incredibly slim margins and consumed too many of Tessco’s assets. By parting ways, Tessco was able to redeploy its assets chasing higher margin business and focusing on a more profitable strategy that should start seeing results in late 2015.

With $11M cash on hand and only $2M in long term debt this should be the bottom of Tessco’s earning woes as they start moving forward. Additionally with a payout ratio of 57% and projected earnings growth of 30% the dividend looks fairly safe and can continue growth based on earnings growth.

Weyco Group (WEYS)

Dividend Yield 2.68%
5yr CAGR 5.3%
Yrs of Dividend Growth 33
Market Cap $305M
Beta 0.61

Weyco Group, together with its subsidiaries, is engaged in the distribution and retail of footwear. It operates in two segments, North American Wholesale and North American Retail. The company designs and markets footwear for men, women, and children under the Florsheim, Nunn Bush, Stacy Adams, BOGS, Rafters, and Umi brand names.

In short there is nothing exciting about Weyco’s business. They have conservative financials (including no long term debt) and specialize in shoes. These are not high fashion models or highly sought after new designer trends but simple and comfortable dress shoes, rain boots & sandals.

As long as there are special occasions, weddings and funerals Weyco will always be there to provide us with the footwear. Their brands are found at most retailers nationwide giving them a niche moat.

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