Small-Cap Dividend Stocks Outperform Again

 | Jan 13, 2012 | 11:30 AM EST
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From time to time I've waxed poetic about my views on dividends, with the primary theory that dividends can be important for reasons beyond just the yield they provide. I believe they can be a meaningful indicator of a company's true financial health.

While companies can manipulate their earnings, they can't manipulate their dividends. If a company raises its dividend year in and year out, this can be a good indicator not only of financial health but also of confident management. This is something that cannot be faked, for very long anyway.

Companies that raise their dividends too high relative to their payout ratio may ultimately have to cut the dividend, and this is rarely if ever heralded by the markets. In a way, this is a nice system of checks and balances.

In the past couple of years, I've published columns focused on identifying smaller companies that have not only a strong record of dividend growth but also the wherewithal to continue raising their dividends in the future. The level of yield here is not of great concern to me, and this is certainly not an income-generation strategy.

The search criteria that I employ for this strategy includes the following parameters: 

  • Market caps between $500 million and $2 billion.
  • Dividend increases in at least each of the past five years.
  • Long-term-debt-to-equity ratios below 50%.
  • Dividend payout ratios below 50% for the trailing 12 months and last two fiscal years.

Last year, 18 companies made the cut, and the average performance of this somewhat well-diversified group of names was quite good, up just over 13%, vs. a gain of 4.3% for the S&P 600 Small Cap Index and a loss of 0.6% for the Russell 2000.

Nu Skin Enterprises (NUS), a direct marketer of anti-aging products, was not only the largest company on the list, it was also the best performer, up 62%. Insurance name RLI (RLI) was second best, up 53%, followed by Bank of the Ozarks (OZRK), up nearly 50%. Overall, 14 names were in positive territory, some just barely, but there were no huge losers in the group.

The worst performers were Badger Meter (BMI, -18%) and my old nemesis, Tootsie Roll (TR), -11%), a still-great brand whose stock has been stagnant for years and whose once-stellar profit margins have fallen by more than 50% since 2004. This company has been ripe for a takeover for years; the only problem is that it is tightly controlled by family management that shows no signs of letting go, despite their advanced ages. I'll save that story for another day.

Overall, I'm pleased with how this screen has performed and will be spending some time this weekend developing a new list of names meeting the criteria, which I hope to publish next week.

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