Don't Forget Small-Caps when Looking for Dividend Yield

Don’t Forget Small-Caps when Looking for Dividend Yield

As we change regimes at the US Federal Reserve, most investors are focused on potential policy changes that could influence markets for the rest of the year.  We are already seeing decisions at the Fed to start reducing stimulus programs as economic data (particularly in the unemployment rate) continue to show improvement.  But, at the same time, there is little reason to believe that we will see major changes in interest rates any time soon.  This means that stocks with strong dividend yields will remain an vogue for the foreseeable future.

Selecting the right stocks, however, is never as easy as looking at dividend yields by themselves.  “Stable stock investments,” said Sam Kikla, markets analyst at BestCredit, “require companies with solid fundamentals that will be able to sustain its dividend payouts without damaging its own prospects for earnings growth.”  Additionally, small-cap stocks mark one of the areas that is often overlooked by investors.  But recent trends in key benchmarks like the Russell 2000 suggest that it might be best to focus on these companies, rather than the large-cap alternatives that are more commonly traded.  The main benefit of these types of investments can be seen in the fact that growth potential increases drastically, when small-cap companies are compared to their large cap counterparts.  Here, we will look at two choices that create the potential for strong growth and stable dividend payouts over the long-term.

Two Stock Choices

(charts created using OT Trend)

On the dividends side, one of the most solid choices can be found in Prospect Capital (PSEC), which is a business development company that offers a massive 11.9% dividend yield for its shareholders.  Benefits here include an impressive project pipeline, a solid balance sheet and a dividend payout ratio that should be supported by the company’s broader growth performance.  In the last three years alone, Prospect has tripled its assets and its growth numbers now top the $5 billion mark.  The company’s quarterly earnings for Q4 2013 showed net investment income at $0.32 per share ($92.2 million), which surpassed initial estimates.  Going forward, the company’s comparatively low borrowing costs (at 5%-6.25%), and supportive lending arrangements with Fannie Mae in its newest real estate ventures suggest we will continue to see upside surprises in Prospect’s quarterly earnings numbers.  With dividend payouts locked-in for most of this year, there is little reason to bet against Prospect at this stage.

On the growth side, we look at Matador Resources MTDR, which is an oil and gas explorer.  In the chart above, we can see that the stock has had a major run higher but is currently experiencing a pullback that could mark an excellent opportunity to start buying once again.  Fundamentally, earnings growth should continue to see support from the increased productivity levels that are coming from its shale site at Eagle Ford -- but earnings numbers have already started coming in at the high-end of early guidance and this could be the driver that propels the stock higher.  Relative to most of its peers, Matador has low debt levels and this should help keep the company from posting any negative surprises in the next few quarters.

Given the current policy environment at the Federal Reserve, it makes sense to start looking for alternative ways of gaining exposure to stocks that are positioned for growth and offer elevated dividend payouts.  Prospect Capital and Matador are some of the best small-cap choices for accomplishing this.