How is the story building up for small cap dividend stocks over the next one year?

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Australian Economy, Macro Economics

It is surprising yet true that a large number of small cap stocks offer exciting dividends which act as a shield against the market volatility and also add to an income stream hence enhancing the investors’ return. A small cap company or a small cap dividend stock is defined as a company with market capitalization of under $2 billion with a decent yield, which may be over 3%. The investors seek consistent, growing payouts and therefore the companies should have sufficient financial capital to continue returning cash to shareholders. While a lot of small or mid cap companies are in a growth phase and therefore retain a large portion of their profits and then reinvest it in the business; there are some small caps that hold the potential to offer superior dividends and more capital appreciation. There can be few factors that can be taken into consideration for relatively high and reliable dividend yield:

  1. The company’s business model / the nature of the assets owned
  2. The size and maturity of the industry/ sector in which the company operates
  3. The degree of specialization of service provided or the point in the lifecycle of the product

The firm’s size provides a signal of the relative risk of its business model, for instance, a large company is expected to have greater share market liquidity, potentially lower price volatility and greater market reach from the financial markets compared to a small or mid-cap company.

The market has provided a number of examples over the years of companies that had “high” dividend yields for a time before it was clear that the yield was not sustainable. These include Goodman Fielder and Pacific Brands, which got delisted/ acquired. The competitive pressures of the industries in which the companies operated and the management’s ability to move their businesses through this competitive landscape, were the key valuations required when determining the sustainability of the dividend yield. Thus, in some cases, the prevailing share price becomes a leading indicator that there is an important risk to the future level of profits and thus the sustainability of the dividend yield. It is up to the investor, in consultation with their adviser, to determine the factors driving the high dividend yield, then determine its sustainability and make a decision on whether the share is appropriate for their portfolio.

At present, Australian economy provides an attractive view to corporate earnings growth and this is expected to be higher in FY19 versus FY18. The domestic economic growth strengthening is expected to be particularly supporting earnings cycle for smaller companies listed on ASX.

An example of small cap dividend stock is Eclipx Group Limited (ASX: ECX) that has a market capitalization of 1.03 billion and annual dividend yield of 4.8%. The group operates in the financial sector and has enhanced its dividends over the last three years. The group reported NPAT degrowth of 3.1% to $27.53 million for the half-year ended 31 March 2018 while revenue from ordinary activities was up 27.43% to $360.21 million against prior corresponding period. Despite the profit degrowth position, the interim dividend was enhanced to 8 cents, compared with 7.5 cents last year.

Even Aged care sector, which has been slammed by the regulatory framework, has stocks like Estia Health Limited (ASX: EHE), having an annual dividend yield of 4.7% which is fully franked. The total dividend/distribution payment amount per security for all dividends/distributions notified is AUD 0.0780. The company has been declaring dividends since 2015.

With over 10% of short selling positions, another small-cap player is Greencross Limited (ASX: GXL), which is a consumer discretionary stock. The stock is currently trading at $4.430 with a market cap of $535 million. This small cap company has an annual dividend yield of 4.4% and is fully franked. The company has been declaring dividend on a regular basis while the full year guidance downgrade has lately impacted the stock.

Then Dicker Data Limited (ASX: DDR) has been a good dividend player over the past few years.

Given the scenario and volatile environment, we expect key small-cap stocks to keep on performing well and delivering high dividends while many large caps like the major banks and insurance groups are trying to reinforce their fundamental positions.

Under sector-specific lens, the financial service sector in Australia has been deeply impacted by the royal commission which also affected a large number of smaller cap ASX listed companies operating in financial services such as platform providers, financial planners and fund managers. Also, the commission plans on to promote independent and advice based model which implies conditions might become apt for emerging financial operators to take the important market share from larger institutions.

The dividend payout ratios remains extremely high internationally, it is believed that the environment of solidifying economic growth and confidence in business is also likely to strengthen. It leads to more M&A activity, where smaller companies are more vulnerable to takeovers. Unlike larger caps where your investments might not lose out much if the entry point is not right like in that of Westpac, but for small caps it requires a lot of experience which matters for better performance of the company. Also, the small-cap sector in the local market has been able to get along with the global technology boom, with firms such as Xero, Altium, Appen and WiseTech being some of the recent successes on ASX, while these do not necessarily pay dividends but may look at the same sometime down the line. Conservative metrics or equity funding can be further add-ons for the small-caps.


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