Small-Caps for Income?

Income-seeking investors shouldn't just stick to big blue-chips. There are plenty of dividend-paying smaller companies out there

Holly Black 15 April, 2021 | 11:27AM
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Dividend payments are typically associated with huge companies; blue-chip behemoths that don’t need to funnel all their spare cash into growing the business. But smaller companies can often be a rich hunting ground for income-seeking investors.

Why is that? Many smaller companies are not start-up firms burning cash to grow, but are established businesses with reliable revenue streams and it makes sense that they would want to use some of their profits to reward shareholders.

Richard Marwood, manager of the Royal London UK Equity Income fund, finds plenty of opportunities in the FTSE 250 – not quite considered the small cap space, but certainly not a world of mega-caps. He holds engineering firm Smiths Group, which has kept growing its dividend, as well as BAE Systems. “You don’t have to be wedded to the mega-caps to get income,” he says.

Retail Stocks for Income?

Gervais Williams, manager of the Premier Miton UK Multi Cap Income fund, likes sofa retailer ScS Group (SCS), which has continued to trade despite the retail sector being forced to stay shuttered over the past year. The firm’s shares are only just getting back to their pre-pandemic levels but the business has remained profitable and, crucially, it currently yields almost 5.5%. What’s more, as many of its competitors have gone bust as a result of the challenges of Covid-19, SCS has used that opportunity to gain market share. And that’s a defining feature of a small business, says Williams: “Some markets can continue to grow through global recessions and if you have a smaller market position, you may even grow that position while the market is going backwards.”

Marwood agrees that selective names in the retail space such as homewares store Dunelm (DNLM) and WH Smith (SMWH) will recover post-lockdown. “We were also able to buy into some higher-yielding stocks such as Sage and National Grid in last year’s sell-off, which are set to benefit from ongoing trends such as electrification,” he adds.

National Grid (NG) shares have since recovered and the stock is rated two stars by Morningstar analysts, indicating that shares are trading above their fair value estimate of 800p. With a yield of 5.5%, their popularity is perhaps not surprising. Indeed, Morningstar analyst Tancrede Fulop points out that the company grew its dividend by an average of 10% a year between 2005 and 2012, though he expects this will be cut to avoid a credit rating downgrade.

Small-Caps Can Keep Growing

Williams, meanwhile, likes the financial sector, where h he believes companies are easily-adaptable to a remote-working environment. The largest position in his fund is spread-betting firm CMC Markets (CMCX), which has enjoyed a spike in customer numbers as people have been more inclined to trade stocks during the market tumult of the past year – that’s partly because people have more time on their hands, and partly due to the headline-grabbing success of stories around the likes of Gamestop and Tesla.

“Shares were £1 when we bought them two years ago and are now nearly £5,” says Williams. “It’s a financially strong business and it’s success is not correlated to the stock market, and we like businesses like that.” The stock currently yields an inflation-busting 4.2% and Williams points out that based on the price he bought the shares, he is effectively enjoying a yield closer to 20%. 

In a year which has seen a raft of dividend cuts from companies considered income stalwarts, it has seemed an achievement for any company to maintain its pay out. Even more impressive are those which have managed to grow their dividend through the pandemic.

Williams points to Diversified Gas & Oil (DGOC) as one example of this – it grew its dividend by 13% last year – while Canadian oil and gas firm i3 energy (I3E) recently announced it would pay its first ever dividend this year. In the US, insurance services business Randall & Quilter (RQIH) has grown its customer numbers, revenue and dividend. The stock yields 4.2%, says Williams, and “you can be confident it will be paid because of the number of new customers it’s bringing on”.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Holly Black  is Senior Editor, Morningstar.co.uk