Take a Dare and Fly With This Dividend Stock

When investors think of dividends, large-cap stocks such as Johnson & Johnson or Procter & Gamble often come to mind. While these are unquestionably strong stocks to buy and hold for steady dividends, investors can also find some hidden gems among small-cap and even micro-cap stocks. Eagle Financial Services is a very small company with a market capitalization of just $88 million. But despite the company's small size, it has a big dividend yield above 4%, and a long history of raising its dividend. And, thanks to its very low market cap, it could have better future growth potential than many of the giants in the banking industry. For investors willing to consider small stocks, Eagle Financial Services could be a rewarding stock for long-term dividend income. The Long Flight Eagle Financial Services is a small bank holding company which owns 100% of the stock of Bank of Clarke County. It serves retail and commercial customers and offers consumer, mortgage and commercial loans as well as other banking services. Eagle Financial Services had total assets of $877 million at the end of last year. Small companies typically do not have long track records of established profitability and consistent growth, but Eagle Financial Services has an impressive company history that goes back 138 years. It has generated steady growth in the many decades since, reaching a peak last year. In fact, 2019 was the first time in the company's history that it generated earnings per share of at least $2.84 and paid dividends over $1 per share. This year has been more challenging for Eagle Financial, and the entire financial sector in the United States, due to the coronavirus crisis. The U.S. economy fell into recession in February, officially, ending the longest economic expansion on record. If that weren't bad enough, the Federal Reserve's move to lower interest rates to near zero is an added headwind for banks, as low rates suppress net interest margins. That said, Eagle Financial has navigated this difficult period relatively well. Eagle Financial Services reported its first-quarter earnings results on May 1, showing the company generated revenues of $9.7 million during the quarter, up 2% from the same quarter last year. Eagle Financial Services reported solid growth rates across several key metrics. The company's loan balances grew to $674 million during the quarter, up $29 million during the last three months. Yield on average loans totaled 4.87%, down slightly versus the previous quarter. This shows the impact of extremely low rates. But very strong loan growth more than offset this small interest rate headwind, meaning total interest income still grew 5.3% year-over-year. Eagle Financial Services' net income was $2.4 million during the first quarter, which equates to earnings-per-share of $0.71 for the quarter. This represented a modest year-over-year decline of 4.1%, but the company remained profitable. Eagle Financial, similar to many other financial institutions, is incurring higher reserves for credit losses as a result of the coronavirus pandemic. Therefore, it is likely that earnings-per-share will decline this year. That said, we view the coronavirus as a short-term downturn for the economy, and expect Eagle Financial to recover in 2021 and beyond. Growth Up Ahead While this year will undoubtedly be a difficult one for all banks and financial services firms, the company should remain profitable enough to pay its dividend in 2020, and raise the dividend in future years. Once the coronavirus crisis is over, the company should return to growth. We expect 5%-6% annual EPS growth over the next five years. The factors underpinning our earnings growth forecast include loan growth, strong interest margins, and effective expense controls. Eagle Financial achieved 6.5% loan growth and 10.6% return on equity in 2019, a more normalized economic environment that we believe is more indicative of the company's typical performance. Continued growth in loans and assets will allow for ongoing interest income growth over the coming years, even with the pressure of low interest rates. Eagle Financial has survived many recessions before, and will do so again, albeit with a sizable impact on its profits. As a financial services company, Eagle Financial is reliant on a healthy economy for growth. In the previous recession, EPS took a sizable hit from 2008-2009. But the company quickly returned to growth once the recession ended, and grew EPS by roughly 10% per year from 2009 to 2019. We also feel the stock is undervalued, given its long-term earnings power. Our estimate of the company's core EPS is $2.90; Eagle Financial shares currently trade at a price-to-earnings ratio below 9-times. The stock also trades for a fairly low price-to-book, or P/B, ratio of 0.88-times, using the company's reported tangible book value per share as of the end of 2019. A higher stock valuation would translate to improved shareholder returns in the years ahead. For example, if the P/E multiple expanded to 11 from the current level, shareholder returns would be boosted by 4.3% per year over the next five years. Dividends will add to shareholder returns going forward. Eagle Financial has an attractive dividend yield of 4.1% and a sustainable dividend payout. With an annualized dividend of $1.04, Eagle Financial has a payout ratio of approximately 36%, based on our estimate of core EPS. This indicates a sustainable dividend payout, even with a challenging economic backdrop. In addition to EPS growth, the 4.1% dividend yield and the impact from a rising P/E multiple, total shareholder returns could reach at least 13% per year over the next five years. This is an attractive projected rate of return, and with a high dividend yield above 4%, the stock has appeal for value and income investors. The high yield compares favorably to current low yielding AAA rated bonds, which are currently offering an effective yield of just around 1.5%. A higher yield, plus the likelihood of future dividend increases is an advantage of Eagle Financial stock vs. bonds. Eagle Financial has increased its dividend for 34 years in a row, an impressive track record for such a small company. It has also shown the ability to outlast recessions, while generating long-term growth, making this an attractive opportunity for investors looking at small cap investments. (Johnson & Johnson is a holding in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells this stock? Learn more now.)

Take a Dare and Fly With This Dividend Stock

Eagle Financial is small bank name that goes under the radar of most investors, but it offers a 4% yield and boasts 34 years of increases.

Columnist Conversation

This Weekend on Real Money

Friday Morning Fibocall for 10/30/2020

Thursday on Real Money Pro

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.