I've long been a believer that dividends represent more than just cash returned to shareholders. While companies can fool investors by "massaging" earnings or announcing stock buybacks and not following through, dividend payouts are hard to manipulate.
In my view, raising a dividend year in and year out is a good indication of not only a company's financial health, but also of a confident management team.
Firms can't "fake" dividend hikes, at least not for very long. Companies that raise payouts to the point of unsustainability risk having to eventually cut their dividends, which is rarely good for a stock. In a way, this creates a system of checks and balances.
But you can also make the argument that dividends are a waste of capital. After all, companies pay federal taxes on their income, then distribute a portion of their profits to shareholders who in turn pay even more tax on it.
Had the money stayed with the company, less capital would have flowed to the U.S. government in the form of taxes paid by shareholders. But of course, theory and practice quickly part ways when it comes to investors' attitude about having cash returned to them in the form of dividends.
I've run a stock screen each January for years that's designed to identify smaller companies with not only strong records of dividend growth, but that also appear to have the ability to continue raising payouts in the future. The level of yield isn't of great concern to me, as this "Small-Cap Dividend-Growers" screen isn't an income-generation strategy.
The search criteria that I employ include:
- $500 million to $2 billion in market capitalization
- 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
Twenty-six companies made the cut this year: Aaron's (AAN), ABM Industries (ABM), American Equity Investment Life (AEL), Applied Industrial Technologies (AIT), Atrion (ATRI), Badger Meter (BMI), BancFirst (BANF), Cardinal Financial (CFNL), Cass Information Systems (CASS), Chesapeake Utilities (CPK), Community Trust Bancorp (CTBI), Computer Services Inc. (CSVI), Ensign Group (ENSG), Finish Line (FINL), Franklin Electric (FELE), Gorman-Rupp (GRC), Horace Mann (HMN), Infinity Property and Casualty (IPCC), International Speedway (ISCA), Quaker Chemical (KWR), Scholastic (SCHL), Standard Motor Products (SMP), StockYards Bancorp (SYBT), Tennant (TNC), Tri-Continental (TY) and Universal (UVV).
There's a great deal of representation from insurance, banking and financial services, including AEL, BANF, CFNL, CTBI, HMN, IPCC, SYBT and TY. By contrast, Finish Line represents the only retailer to make the cut, although FINL has been showing on a few of my screens recently.
Another firm, tobacco company Universal, is a crossover from my "Double-Net Dividend Portfolio." The remaining 16 stocks in my Small-Cap Dividend-Growers Portfolio come from a hodge-podge of industries.
The group's average yield is about 2%, while the average market cap is just over $1 billion and the average dividend-payout ratio is 30% on a trailing-twelve-month basis. The constituent stocks are also light on debt, with an average long term debt-to-equity ratio of just 0.15.
This screen has worked fairly well in the past, but with all of the market volatility that I expect this year (not to mentioned a rising interest-rate environment), 2016 might be a real test for the strategy. I'll be benchmarking the portfolio against the Russell 2000 and S&P SmallCap 600 and following the 26 stocks' progress throughout 2016.