5 small-cap stocks for dividend investors

The high-yielding charms of Penske Automotive, Graphic Packaging, Hanover Insurance, Validus, and First Hawaiian.

  • By Lawrence C. Strauss,
  • Barron's
  • Investing in Stocks
  • Dividend-Paying Stocks
  • Small-Cap Stock Funds
  • Investing in Stocks
  • Dividend-Paying Stocks
  • Small-Cap Stock Funds
  • Investing in Stocks
  • Dividend-Paying Stocks
  • Small-Cap Stock Funds
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When it comes to dividends, much attention is paid to large companies. And rightly so, given that many have a lot of free cash to sustain and grow their payouts.

Plenty of small-cap stocks pay reliable dividends, too. Barron's recently looked for companies with market capitalizations of at least $2 billion, dividend yields above 2%, and payout ratios—the percentage of net income paid out as dividends—around 50% or lower. The table shows five that meet our criteria, and are picks of Jeff John and Miles Lewis, co-managers of the $1.6 billion American Century Small Cap Value fund (ASVIX). They also applaud these five companies' fundamentals, in particular their ability to generate free cash.

A dozen stocks for income

Consumer stocks can be less prone to revenue declines and tend to offer solid payouts.

One of their holdings is Penske Automotive Group (PAG), which sells and services cars. Concerns about slowing auto sales have weighed on the stock, which is down 16% this year, although it has returned about 50% in the past 12 months. John notes that in Penske's first quarter, 41.5% of the gross profit in its retail automotive unit came from parts and service, which provide recurring revenue—and plenty of cash for dividends, share buybacks, and mergers and acquisitions.

The parts and service business accounted for only 10.5% of revenue, testament to its profitability. New vehicles, which the company sells through dealerships, generated nearly half of first-quarter sales, but only 25% of gross profit. Penske also sells used vehicles.

The company recently increased its quarterly dividend to 31 cents a share, up 3% from 30 cents. Its stock yields 2.8%.

Another high-yielding stock in the fund is Graphic Packaging Holding (GPK), which makes paper packaging, including folding cartons for cereal, frozen food, and beer bottles. Given its focus on consumer staples, the company is fairly resilient.

Graphic launched its dividend in 2015, and its payout ratio is only 27%, leaving plenty of room for more increases. "They have ample room to grow free cash flow per share at mid- to high-single digits over the next few years," says Lewis. That, combined with a lower payout ratio, should support dividend growth.

The fund also sees good value in Hanover Insurance Group (THG). The property-casualty insurer does a lot of business with small and middle-market outfits, and handles insurance for individuals, including auto and homeowners' coverage.

The stock yields 2.3%. Analysts expect Hanover to earn $6.02 a share this year and $7.06 next year, up from $4.27 in 2016. Its payout ratio was only 44% last year. Hanover's payout has grown at a double-digit annual rate in recent years, "and we expect them to grow it 10% to 12% a year over the next three to five years," says Lewis.

The portfolio managers' other recommendations are multiline insurer Validus Holdings (VR) and First Hawaiian (FHB), which has one of the largest market shares among banks in the Aloha state. Helped by strong free cash flow, Validus has boosted its quarterly dividend regularly, most recently in February, by nearly 9%, to 38 cents a share.

Smaller caps, bigger yields

These five small-cap stocks sport yields above 2% and still have room to grow their dividends.

Company Ticker Div Yield Market Value (bil.) 1-Year Tot. Return Div. Payout Ratio*
First Hawaiian FHB 2.9% $4.3 N/A 53.7%
Validius Holdings VR 2.9 $4.1 12.0% 36.1
Penske Automotive Group PAG 2.8 3.8 50.6 28.5
Hanover Insurance Group THG 2.3 3.8 8.3 43.8
Graphic Package Holding GPK 2.2 4.3 15 27.4

Source: Barron's

First Hawaiian, which went public last year, "has a great deposit franchise and conservative credit culture," says Lewis. Analysts expect the company to pay dividends of 88 cents a share this year and 99 cents in 2018, for a 12.5% increase.

Share buybacks, dividends' biggest competition, dropped 17.5%, to $133.1 billion, at Standard & Poor's 500 (.SPX) companies in the first quarter, from a year-earlier $161.4 billion, according to preliminary data from S&P Dow Jones Indices. "Fewer buybacks resulted in fewer share-count reductions and less earnings-per-share support," notes Howard Silverblatt, the group's senior index analyst.

This happened as cash levels hit record levels. "The companies had the money, but chose not to prime their EPS as much as they did in prior quarters, leading some to believe that companies have a good degree of confidence that second-quarter 2017 EPS will do well without the tail wind" of buybacks, Silverblatt observes.

What's more, many of the first quarter's repurchases were concentrated among certain companies. The top 20, in dollar value of shares repurchased, accounted for 42% of the buybacks.

Financials were the biggest repurchasers, accounting for 22.2% of the buybacks. No. 2, the tech sector, accounted for 20.6%, and saw the actual amount spent drop 4.4%, year over year, to $27.5 billion.

And energy, which has begun to recover, doubled its repurchases to $2.1 billion, well below the $13.1 billion companies in the sector spent in 2014's first quarter, when oil and gas prices were much higher.

The top individual spenders: Apple (AAPL) repurchased $7.2 billion of stock in the first quarter, versus $6.7 billion a year earlier.

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