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  1. Home
  2. / Investing

Four Quality Stocks for Income Investors

Combining two theories produces these solid small-cap names.
By TIM MELVIN Jan 28, 2015 | 01:00 PM EST
Stocks quotes in this article: SGU, UTI, HMC, F, HOG, GM, DEST, KSS, CLCT

This week I have been focusing on ways to apply a theory from Cliff Asness of AQR Capital about high-quality small-cap stocks and the potential for outsized returns. I am also using an approach from Robert Novy-Marx of Rochester University to identify quality in financial statements, as I've found that it works very well. I was asked if this approach was of any value to investors also seeking income and am happy to say that it most certainly does.

Running a screen for small quality companies that also pay a decent dividend, I found some really interesting stocks. I have mentioned Star Gas Partners (SGU) many times in the past and it remains one of my all-time favorite dividend stocks. Connecticut-based Star Gas is the nation's largest retail distributor of home heating oil, based upon sales volume, and operates in the Northeast and Mid-Atlantic regions. It has consolidated "mom and pop" heating oil and propane stores into a good size company over the years. With gross profits $406 million on total assets of $685 million, Star Gas meets my definition of high quality, and the stock is yielding 5.43%. When someone asks me for a stock to buy for steady reliable income this is always one of the first ones I mention.

While I have not been a big fan of for-profit education stocks, one that stands out from the pack is Universal Technical Institute (UTI). Universal trains people for careers as automotive, diesel, collision repair, motorcycle, and marine technicians. The company has relationships with major manufacturers Honda Motor (HMC), BMW, Ford Motor (F), Harley-Davidson (HOG), General Motors (GM) and others to provide manufacturer-specific training programs that give its students enhanced employment opportunities.

Universal also has a NASCAR Tech program that offers the same type of automotive training as other UTI locations, along with additional NASCAR-specific elective courses. While the bulk of NASCAR Tech graduates go on to regular repair shop and dealership jobs, in 2013 and 2012 approximately 19% and 15%, respectively, of the graduates from the NASCAR program found employment opportunities in the racing industry. Companywide employment rates for 2013 and 2012 graduates were 88% and 85%, respectively, which is well above most of the for-profit traditional schools.

In the past 12 months, Universal produced $178 million of gross profits on total assets of just $288 million, so it is a "Novy-Marx" high-quality stock. The dividend yield of 4.71% at the current price makes it an attractive income stock as well.

Destination Maternity (DEST) popped up on the screen and went immediately to the top of my "please fall below book value so I can buy this stock" list. It is not yet "Tim Cheap," and may never get there, but it is worth considering for income investors. The company sells maternity clothes, an always in demand product, through 1,894 retail locations, including 568 stores operating predominantly under the names Motherhood Maternity, A Pea in the Pod, and Destination Maternity, and 1,326 leased department locations in department stores in the U.S. and Canada. It also sells a line of Oh Baby by Motherhood maternity clothes in Kohl's (KSS) stores across the U.S. The company also does business in Middle East, South Korea, Mexico and Israel.

DEST stock is down after the company had two consecutive negative earnings surprises, but the last time I looked folks were still having kids and Destination Maternity is world's largest designer and retailer of maternity apparel. It easily makes the grade as a high-quality stock as gross profits actually exceed total assets. The company had gross profits of $269 million on total assets of $230 million in the past 12 months. The dividend yield is currently a very attractive 5.06%.

Another company with gross profits that exceed total assets is Collectors Universe (CLCT). The company had gross profits of $39 million on total assets of just $33 million. Collectors provides third-party authentication, grading, and related services for collectibles such as coins, trading cards, sports memorabilia, and autographs. It also provides websites for trading in collectible items. The stock is yielding 5.38% right now and the dividend was just increased. In addition, Collectors has a solid record of increasing the payout, with about 10% annual dividend growth over the past five years.

Combining the theories of Cliff Asness and Robert Novy-Marx produces a solid list of small, high-quality income stocks. It is not a very long list, but the approach should help income-oriented investors add diversification and high income to their current portfolio.

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At the time of publication, Melvin had no positions in any of the securities mentioned.

TAGS: Investing | U.S. Equity

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