As the market surges ever-higher, investors have begun to wonder just how much more altitude it has in it before it stalls. We’ve seen roughly five-straight years of gains since the depths of the recession so it’s understandable that investors are getting a bit nervous. To that end, they’ve begun to shun many risk assets.

And lately, that means many small-cap stocks. (For more on investing in small-caps, see Small Caps Boast Big Advantages).

Dividends Are Key

As the “risk-off” trade has once again crept back into investors’ minds, high-growth and high-priced stocks have been sold off. This includes small-caps; the sector has fallen behind their larger brethren in terms of performance. The segment benchmark – the iShares Russell 2000 ETF (IWM) – has dropped about 4.3% year-to-date, while the S&P 600 has fallen 3.3%. Meanwhile, the large-cap S&P 500 has gained about 3%.

And given some of the headwinds facing the economy, some analysts predict that small-cap volatility should persist throughout the year. When viewed over the long term, however, the historical outperformance of small-caps shouldn’t be ignored, largely because they offer the cushion of dividends.

In the current sell-off, we’ve already begun to see the power of dividends in the small-cap space. The Russell 2000 Value Index, which features many small-cap dividend payers, is down only 2.7% year-to-date.

Conventional wisdom dictates that small companies need to reinvest every last penny into their businesses in order to fund growth. But just as in the large-cap world, dividends in the small-cap space point to steady cash flows, low debt and overall financial discipline. And those dividends can point to longer-term outperformance, as well. Between 1993 and 2011, the average annual total return for the Russell was 10.1% for those small-cap firms that paid dividends. That compares to just a 6.2% for those that do not, and an 8% return for the entire index.

How to Add a Dose of Small-Cap Dividends

For investors looking to add some small-cap dividend muscle to their portfolios, there are a few ways to gain exposure. And with rocky days ahead, the time to do that could be now. To that end, ETF issuers WisdomTree Investments Inc. (WETF) offers several products to gain exposure. The biggest of which is the $1 billion WisdomTree SmallCap Dividend Fund (DES).

DES offers investors a broad starting point for getting some yield out of smaller firms. The ETF tracks 685 different small-cap dividend payers, including cigarette maker Vector Group Ltd. (VGR) and salt miner Compass Minerals International Inc. (CMP). DES currently yields 2.85%. That focus on dividends has the ETF returning a whopping 80% since its inception in 2006. Another interesting fund from WisdomTree is its new WisdomTree U.S. SmallCap Dividend Growth Fund (DGRS). The idea is similar, except DGRS screens for those firms that have consequently grown their dividends, rather than just focusing on yield.

Another potential option is to focus on value stocks within the small-cap space. The iShares Russell 2000 Value (IWN) and iShares S&P Small-Cap 600 Value (IJS) track the previously mentioned value versions of their parent indexes. Both yield more and have held up better in the wake of rout. Another option could be the PowerShares S&P SmallCap Low Volatility (XSLV). XSLV tracks the 120 stocks within the S&P 600 with the lowest realized volatility over the past 12 months. That also boosts the dividend yield of XSLV to 2.36%.

Finally, as with large-caps, certain sectors generally pay more than others. Small-cap utilities can be a fertile hunting ground for dividend seekers. Diversified power producer Otter Tail Corp. (OTTR) currently yields 4.3%, while water utility American States Water Co. (AWR) yields 2.9%. (For more on small-cap investing basics, see An Introduction to Small Cap Stocks)

The Bottom Line

Small-cap stocks have taken a beating at the hands of jittery investors. But there are opportunities if you focus on dividend-paying companies. Fortunately, there are several strategies to get exposure to dividend-paying small-cap stocks, including ETFs and sector-specific plays.

Related Articles
  1. Trading Strategies

    Small Caps Boast Big Advantages

    Find out why little companies have the greatest potential for growth.
  2. Markets

    An Introduction To Small Cap Stocks

    When it comes to a company's size, bigger isn't always better for investors. Find out more here.
  3. Mutual Funds & ETFs

    Why ETFs Are a Smart Investment Choice for Millennials

    Exchange-traded funds offer an investment alternative to cost-conscious millennials who want to diversify their portfolios with less risk.
  4. Stock Analysis

    Will J.C. Penney Come Back in 2016? (JCP)

    J.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
  5. Mutual Funds & ETFs

    Should Investors Take a BITE Out of This New ETF?

    ETF BITE offers a full menu of restaurants. Is now the right time to invest?
  6. Stock Analysis

    If You Had Invested Right After Coca-Cola's IPO

    Discover how one $40 share, with dividend reinvestment, over 90 years ago in the Coca-Cola Company would have made you a multimillionaire today.
  7. Stock Analysis

    If You Had Invested Right After Cisco's IPO

    Discover how Cisco became one of the greatest IPOs in history during the 1990s and how it continues to innovate and move forward today.
  8. Stock Analysis

    If You Had Invested Right After Amgen's IPO

    Discover how $1,000 invested in Amgen during its initial public offering (IPO), without reinvesting dividends, would be worth over $427,000 as of November 2015.
  9. Financial Advisors

    5 Things All Financial Advisors Should Know About ETFs

    Discover five things all financial advisors should know about ETFs, including when ETFs may be a better choice for your clients than mutual funds.
  10. Stock Analysis

    The Biggest Risks of Investing in ConocoPhillips Stock

    Understand the risks of investing in ConocoPhillips stock. Learn about how there is a risk of a dividend cut due to lower prices for crude oil.
  1. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  2. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  3. What are the dividend reinvestment options for a mutual fund?

    There are two primary choices for how investors can choose to handle dividend distributions made by mutual funds that they ... Read Full Answer >>
  4. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  5. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  6. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>

You May Also Like

Trading Center