Published Fri, 23 Nov 2018 13:02:55 on Income Investors
Why Income Investors Should Take a Look at Small-Cap Dividend Stocks
When you utter the words “dividend stocks,” most people will be thinking of established dividend payers like Walmart Inc (NYSE: WMT) and The Coca-Cola Co (NYSE: KO). Indeed, these companies have been around for a very long time and have impressive track records of paying cash distributions to investors.
Do you know what these well-known names also have in common?
Giant market capitalizations.
In the investment community, we usually define a large-cap stock as one with a market capitalization of more than $10.0 billion. The two companies I mentioned above fall into this category as each of them commands a market cap north of $200.0 billion.
The thing is, though, because large-cap stocks are so well-known, they have become extremely popular as income investors searched for yields over the last several years. One consequence of such investor enthusiasm is an increase in their stock price.
And since dividend yield moves inversely to a company’s share price, the popular large-cap stocks don’t offer much in terms of current payout. Looking at the above two companies again, we see that Coca-Cola stock has an annual yield of 3.1%, while Walmart stock yields just 2.1%.
That’s why in this article, I want to show you a way to boost the return of an income portfolio. And that involves taking a look at the lesser-known tickers.
In particular, I’m talking about small-cap dividend stocks. Small-cap stocks are generally defined as publicly traded companies with a market cap of between $300.0 million and $2.0 billion. There are plenty of small-cap names in the market, but I’m looking at them from a dividend investor’s perspective.
Some say that small-cap stocks offer faster growth potential than large-cap stocks because they are less established and are still in the expanding stage of their businesses. But of course, on the flip side is increased risk. An investor should take both of these arguments into account when delving into the numerous small-cap stocks in today’s market.
I also want to point out—and this is of particular interest to income investors—that small-cap stocks can sometimes offer huge yields.
Think about it like this: If a company is so successful that it has become a household name and commands $500.0 billion of market cap, investors will likely jump at the opportunity to own it. And if that company offers a yield that’s even slightly higher than usual, investors will rush toward it. They would bid up its price and that high yield would be gone.
That’s why, if you take a look at the S&P 500 Index, which consists of the biggest companies in the U.S. stock market, you’d see that the average dividend yield of its components is just 1.9%. (Source: “S&P 500 Dividend Yield,” Multpl.com, last accessed November 16, 2018.)
Small-cap stocks, on the other hand, can be much more generous. While they also tend to carry more risk, many investors have been using them to improve the yield of their dividend portfolios.
Below, I have compiled a list of three small-cap dividend stocks, which should provide a good point for investors to start looking in 2019.
List of 3 Small-Cap Dividend Stocks for 2019
Company Name Stock Exchange Ticker Symbol Dividend Yield LTC Properties Inc NYSE LTC 5.2% Oasis Midstream Partners LP NYSE OMP 8.7% Consolidated Communications Holdings Inc Nasdaq CNSL 12.0% 1. LTC Properties Inc The first thing to note, before we even go into the picks, is that when I say small-cap stocks, I’m not talking about some shaky business that may shut down operations at any point. Even though small-cap stocks are generally not as established as large-cap ones, some of them actually have solid operations. And only when a small-cap company generates a recurring business does it deserve the attention of income investors.
The good news is, LTC Properties Inc (NYSE: LTC) has been running a recurring business for quite some time. Headquartered in Westlake Village, California, LTC Properties is a real estate investment trust (REIT) that focuses on seniors housing and healthcare properties.
Like most REITs, LTC Properties operates like a giant landlord. The company’s portfolio currently consists of 103 assisted living communities, 95 skilled nursing centers, and one behavioral health care hospital. These 199 properties are diversified across 28 states. (Source: “REITWorld: 2018 Annual Conference,” LTC Properties Inc, last accessed November 16, 2018.)
The company collects rent from its tenants/operators, then passes some of that money to shareholders through dividends. This simple but stable business model has rewarded LTC stock investors for quite some time.
And because the business is so stable, management has decided to return cash to shareholders monthly rather than quarterly. With a monthly dividend rate of $0.57 per share, LTC stock offers an annual yield of 5.2%.
The payout might not seem like much compared to the other two stocks that I will talk about in this article, but keep in mind that at 5.2%, LTC’s yield is already more than twice that of the average S&P 500 company.
Moreover, the company has no problem covering its payout. In the third quarter of 2018, LTC Properties generated $27.1 million in funds available for distribution (FAD). This resulted in a FAD payout ratio of 82.6%, leaving a margin of safety. (Source: “LTC Reports 2018 Third Quarter Results,” LTC Properties Inc, November 5, 2018.)
2. Oasis Midstream Partners LP Moving up in the yield ladder is Oasis Midstream Partners LP (NYSE: OMP), a master limited partnership (MLP) headquartered in Houston, Texas. It was created by Oasis Petroleum Inc (NYSE: OAS), to own, develop, operate, and acquire midstream energy assets.
Now, you are probably wondering why I’m talking about an energy partnership when oil prices are crashing.
Well, the answer is simple. Despite the volatility in commodity prices, Oasis Midstream Partners has no problem returning an increasing stream of cash to its investors. Since the partnership’s initial public offering (IPO) in September 2017, management has raised the payout every quarter.
The latest distribution hike, which was announced last month, boosted OMP stock’s quarterly payout by five percent sequentially to $0.43 per unit. (Source: “Oasis Midstream Partners Announces Quarterly Distribution,” Oasis Midstream Partners LP, October 30, 2018.)
Trading at around $19.80 apiece, Oasis Midstream offers investors a generous annual yield of 8.7%.
The best part is, investors who purchase OMP stock today will likely collect even higher yield on cost as we enter 2019.
In the latest investors presentation, management made it clear that they are targeting “organic 20% distribution per unit growth rate past 2021.” (Source: “November 2018 Investor Presentation,” Oasis Midstream Partners LP, last accessed November 16, 2018.)
Given what the company has been doing, unitholders will likely continue to get a pay raise every three months.
The distribution is also safe. In the third quarter of 2018, Oasis Midstream Partners generated $14.4 million in distributable cash flow, providing 1.22 times coverage of its payout for the quarter. (Source: “Oasis Midstream Partners LP Announces Quarter Ended September 30, 2018 Earnings,” Oasis Midstream Partners LP, November 5, 2018.)
Going forward, management expects its distribution coverage to improve, entering 2019 at around 1.4 times and increasing to 1.6 times to 1.7 times for the remainder of 2019.
When it comes to income investing in the energy sector, things don’t get much better than a safe distribution that grows on a quarterly basis.
3. Consolidated Communications Holdings Inc To round off the list of small-cap dividend stocks is Consolidated Communications Holdings Inc (Nasdaq: CNSL), a broadband and business communications provider headquartered in Mattoon, Illinois.
In today’s market, the No. 1 reason to consider CNSL stock is to collect its outsized dividends. Paying investors $0.38738 per share on a quarterly basis, the company offers a jaw-dropping yield of 12%.
And while an ultra-high yield could simply be a sign of trouble, Consolidated Communications actually has a solid business to back its payout.
You see, the company is in the telecommunications business. Through its fiber-optic network, CNSL provides voice, video, data, managed services, cloud computing, and wireless backhaul to customers in a 23-state service area.
As an income investor, I like telecom companies because of the high barriers to entry of the industry. It takes a lot of capital to build or acquire the infrastructure needed to offer communications services.
Consolidated Communications is already one of the top 10 fiber providers in the country, with 36,000 fiber network miles, 9,600 on-net buildings, 3,300 fiber connections for wireless providers, and 785,000 data and Internet connections. With a limited number of new entrants to the industry, existing companies like CNSL gets to earn oversized profits.
In the third quarter of 2018, Consolidated Communications generated $39.5 million in cash available to pay dividends. Its dividends paid, on the other hand, totaled $27.6 million. That translated to a payout ratio of just under 70%. (Source: “Consolidated Communications Reports Third Quarter 2018 Results,” Consolidated Communications Holdings Inc, November 1, 2018.)
In the first nine months of this year, CNSL’s cash available to pay dividends totaled $123.0 million. Since the company paid $82.6 million in dividends during this period, its payout ratio came out to 67.1%. Therefore, the payout was safe.
Final Thoughts on Small-Cap Dividend Stocks
The three companies I discussed above offer substantial yields and can cover their payout. However, there is still a case for income investors to put an emphasis on large-cap stocks, and especially household names in defensive industries.
This is, in part, due to the uncertainties in the market right now. When investors go from risk-on to risk-off, they want to own companies that can stand the onslaught of recessions, such as Procter & Gamble Co (NYSE: PG) and Johnson & Johnson (NYSE: JNJ). These companies tend to command giant market capitalizations.
Bottom line: Small-cap stocks can pay big dividends, but they should be more used as yield-boosters rather than the bread and butter of an income portfolio.
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|Stock name||Last trade||P/E||Earnings/Share||Dividend/Share||Dividend yield|
|JOHNSON & JOHNSON||130.43||21.6||6.03||3.80||2.93|
|PROCTER & GAMBLE||122.77||90.3||1.36||2.98||2.49|
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