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Small Caps Are For Dividends Too
With the market whip-sawing its way back and forth, many investors have been turning their attentions back towards dividend investing. Exchange-traded funds (ETFs) such as the SPDR S&P Dividend (ARCA:SDY), which tracks a broad-basket of dividend paying companies, have become immensely popular with investors as they seek income as well as safety. However, in that search for strong yields, many portfolios generally turn towards the high dividends and long track records of the market's largest firms. Conversely, some of the best opportunities for dividend hunters could lie within the smaller side of the stock market.
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Think Small
Generally, when investors look towards small-cap stocks, they do so from a vantage point of growth. The iShares Russell 2000 Index (ARCA:IWM) has been a top long-term performer over the years. A famous study by economists Fama and French, concluded that small caps outperformed their large-cap twins by over four percentage points annually from 1956 to 2005. Yet, when it comes to dividends investors often ignore their potential.
Roughly seven of the largest blue chip stocks account for around 50% of all dividend payouts. Adding in the next 10 payers represents more than 80% of all dividends. So it's not surprising that investors ignore smaller firms when hunting for income. However, that could be a big mistake.
General consensus is that small companies need to plow every available penny back into the business in order to fund their growth. However, just as in the large-cap world, dividends in the small space show financial discipline, often steady cash flows and low debt. These added dividends have many positive effects, including lower volatility and perhaps most important of all - higher returns. When comparing dividend paying small caps in the Russell 2000 to those who do not pay, the dividend payers beat their non-paying twins by a large percentage. Between 1993 and 2011, the average annual total return for the 19-year period was 10.1% for small-cap dividend payers. That compares to just a 6.2% for those that do not, and an 8% return for the entire index.
Additionally, despite an abundance of small-cap companies that pay dividends, very few institutional managers focus on dividends within the small-cap universe. That can provide plenty of yield and growth opportunities for retail investors looking for ignored bargains.
SEE: An Introduction To Small Cap Stocks
Adding Those Small Powerful Payers
Given the dividend paying prowess of small-caps, investors may want to allocate some capital towards the sector. The WisdomTree SmallCap Dividend (ARCA:DES) offers investors a broad starting point for getting some yield out of smaller firms. The ETF tracks 622 different dividend payers including CommonWealth REIT (NYSE:CWH) and shipper Tal International (NYSE:TAL), with the bulk of its holdings in the financial sector. The fund charges a cheap 0.38% in expenses and yields 3.48%. Likewise, the new Russell Small Cap High Dividend Yield ETF (ARCA:DIVS) can offer exposure as well.
Like their large-cap sisters, small-cap utilities are star dividend payers as well. Minnesotan electricity provider ALLETE (NYSE:ALE) currently yields 4.4%, while Otter Tail (Nasdaq:OTTR) yields 5.2%. To that end, exposure to the PowerShares S&P SmallCap Utilities (Nasdaq:PSCU) might be prudent. The ETF tracks the 23 utility stocks in the S&P SmallCap 600 index. The fund yields a strong 3.68% and charges 0.29% in expenses.
Finally, a bit of active management might make sense in the sector. Asset manager Royce Associates strictly focuses on small-cap stocks and makes dividends a top priority when selecting holdings. While, it's not technically a dividend fund, the closed-end fund Royce Value Trust (NYSE:RVT) could make a great small-cap dividend play. The closed-end fund yields 6% and many of the fund's holdings either pay dividends or have the ability to. Additionally, the fund currently can be had for a 12% discount to its net asset value.
SEE: Finding The Best Fund Manager
The Bottom Line
Investors are returning to dividends both as a source of income and to smooth out the markets return to volatility. However, most of investors' focus is towards larger capitalized stocks. Small-cap dividend payers offer many of the same benefits and shouldn't be ignored in portfolios. The preceding picks, along with the WisdomTree International SmallCap Dividend (ARCA:DLS) are good places to start a search for small-cap income.
At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.
Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers
Think Small
Generally, when investors look towards small-cap stocks, they do so from a vantage point of growth. The iShares Russell 2000 Index (ARCA:IWM) has been a top long-term performer over the years. A famous study by economists Fama and French, concluded that small caps outperformed their large-cap twins by over four percentage points annually from 1956 to 2005. Yet, when it comes to dividends investors often ignore their potential.
Roughly seven of the largest blue chip stocks account for around 50% of all dividend payouts. Adding in the next 10 payers represents more than 80% of all dividends. So it's not surprising that investors ignore smaller firms when hunting for income. However, that could be a big mistake.
General consensus is that small companies need to plow every available penny back into the business in order to fund their growth. However, just as in the large-cap world, dividends in the small space show financial discipline, often steady cash flows and low debt. These added dividends have many positive effects, including lower volatility and perhaps most important of all - higher returns. When comparing dividend paying small caps in the Russell 2000 to those who do not pay, the dividend payers beat their non-paying twins by a large percentage. Between 1993 and 2011, the average annual total return for the 19-year period was 10.1% for small-cap dividend payers. That compares to just a 6.2% for those that do not, and an 8% return for the entire index.
Additionally, despite an abundance of small-cap companies that pay dividends, very few institutional managers focus on dividends within the small-cap universe. That can provide plenty of yield and growth opportunities for retail investors looking for ignored bargains.
Adding Those Small Powerful Payers
Given the dividend paying prowess of small-caps, investors may want to allocate some capital towards the sector. The WisdomTree SmallCap Dividend (ARCA:DES) offers investors a broad starting point for getting some yield out of smaller firms. The ETF tracks 622 different dividend payers including CommonWealth REIT (NYSE:CWH) and shipper Tal International (NYSE:TAL), with the bulk of its holdings in the financial sector. The fund charges a cheap 0.38% in expenses and yields 3.48%. Likewise, the new Russell Small Cap High Dividend Yield ETF (ARCA:DIVS) can offer exposure as well.
Like their large-cap sisters, small-cap utilities are star dividend payers as well. Minnesotan electricity provider ALLETE (NYSE:ALE) currently yields 4.4%, while Otter Tail (Nasdaq:OTTR) yields 5.2%. To that end, exposure to the PowerShares S&P SmallCap Utilities (Nasdaq:PSCU) might be prudent. The ETF tracks the 23 utility stocks in the S&P SmallCap 600 index. The fund yields a strong 3.68% and charges 0.29% in expenses.
Finally, a bit of active management might make sense in the sector. Asset manager Royce Associates strictly focuses on small-cap stocks and makes dividends a top priority when selecting holdings. While, it's not technically a dividend fund, the closed-end fund Royce Value Trust (NYSE:RVT) could make a great small-cap dividend play. The closed-end fund yields 6% and many of the fund's holdings either pay dividends or have the ability to. Additionally, the fund currently can be had for a 12% discount to its net asset value.
SEE: Finding The Best Fund Manager
The Bottom Line
Investors are returning to dividends both as a source of income and to smooth out the markets return to volatility. However, most of investors' focus is towards larger capitalized stocks. Small-cap dividend payers offer many of the same benefits and shouldn't be ignored in portfolios. The preceding picks, along with the WisdomTree International SmallCap Dividend (ARCA:DLS) are good places to start a search for small-cap income.
At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.
by
Aaron Levitt
Aaron Levitt is a SABEW investment journalist and analyst living in State College, Pennsylvania. His work appears in several high profile publications in both print and on the web. Aaron is a graduate of The Pennsylvania State University where he studied Economics and International Business and he is an advocate for long-term investing with a global framework. You can follow his picks and pans at @AaronLevitt
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