Large-cap high-quality dividend growth stocks are kind of my bread-and-butter, both as an investor and a writer.
That’s because there’s an element of safety there when you’re investing in the likes of Johnson & Johnson (JNJ) or PepsiCo, Inc. (PEP).
These are mega-companies that are unlikely to suffer any kind of business shock that would imperil their ability to pay increasing dividends, which offers me more than a modicum of assurance that my passive income should continue to roll in and increase.
It’s really all about minimizing risk of income loss. I want to invest in the safest dividends out there.
Moreover, most companies that have had the time to build up a track record of increasing dividends for decades on end are large by their very nature, as all those years of increasing profit (which is used to fund those increasing dividends) means the companies are becoming worth more as a consequence.
In addition, most small companies that are just starting out need to retain and reinvest most or all of their profit, as this capital is used to continue to growing operations precisely when both growth potential and the thirst for capital are at their peak.
As such, it’s not common to find small companies that have paid shareholders increasing dividends for years on end.
But that’s not always the case.
In fact, some of my best investments (in terms of both aggregate dividend income and total return) have been in the small-cap space.
And so I’m going to discuss a few small-cap dividend growth stocks that have done fairly well for me. And I think all of them have safe dividends, high-quality fundamentals, and competitive advantages.
In my opinion, all of them are fairly good long-term investment opportunities today.
The following text will not represent full analyses; rather, I’m just providing some compelling long-term ideas for further research.
Armanino Foods of Distinction Inc. (AMNF)
Armanino Foods of Distinction produces, markets, and sells a variety of frozen Italian specialty foods.
This is one of my favorite stocks in my portfolio. And that’s saying a lot when considering I’m invested in more than 100 different businesses.
While a lot of large food companies out there are struggling to grow right now, Armanino Foods continues to grow both its top and bottom lines at healthy rates, which allows for continued dividend growth. On top of that, the stock is available at a discount to most other stocks in the packaged food space.
The company just registered its highest-ever quarterly sales and earnings report. For perspective, net sales for Q2 FY 2017 increased by 18% YOY; earnings per share grew by 17%. And this is all while they continue to reinvest back in the business via a plant expansion project.
The balance sheet is spotless. And profitability is outstanding.
This is a company with a market cap of only ~$71 million, so that’s something to keep in mind.
But they’ve nonetheless paid an increasing dividend for 11 consecutive years. The 10-year dividend growth rate is 12.3%. The payout ratio is a little over 60%. The odds appear strong that the company continues to not only pay a dividend, but increase it at a rate strongly in excess of inflation.
With a P/E ratio of under 18 (well below the broader market and most other food stocks) and a yield of 3.60% (well above the market and most other food stocks), this small-cap dividend growth stock is a real gem, in my view.
Southside Bancshares, Inc. (SBSI)
Southside Bancshares is a bank holding company based out of Texas.
This small bank (market cap of just over $1 billion) is a well-run financial institution that just continues to deliver year after year.
The company just recently announced results for its second quarter of FY 2017.
All they did was increase diluted EPS by almost 17% while also improving ROE and ROA.
With 23 consecutive years of dividend increases, a 10-year dividend growth rate of 13.4%, a payout ratio of ~60%, and a yield of 2.79%, there’s pretty much nothing to like about this stock from a dividend growth perspective. Plus, the company pays out a 5% stock dividend every year. And that’s on top of regular special dividends, too.
Indeed, the dividend metrics are better than what the big domestic banks offer, as Southside never cut its dividend during the financial crisis.
That’s because the bank barely blinked over that time frame, with revenue and EPS more or less chugging right along from 2007-2010.
While I view small banks as particularly risky, Southside has never given me reason to be concerned.
The valuation might be the only thing to not like here. With a P/E ratio of 19.11, it’s trading above its five-year average. However, I think this is a bank that was arguably cheaper than it should have been over that time frame, which perhaps leaves some room for the correction of a prior incorrect valuation. Said another way, I think some of the valuation expansion has been warranted.
OTC Markets Group Inc. (OTCM)
OTC Markets Group operates financial markets for over 10,000 securities in the US and globally.
The market cap for this company is just under $275 million.
Talk about an oligopoly. If you want to list securities, you have very limited options. When you buy stocks, you’re primarily buying stocks via the NYSE, Nasdaq, or OTC platforms. And while their Pink open market is often known as “pink sheets”, many large-cap stocks are listed on OTC platforms. For instance, Nestle SA (NSRGY) is an OTC stock. So is AMNF (discussed above). Of course, so is OTCM. Cheaper costs and/or lower regulatory hurdles are just a couple reasons to choose an OTC platform over a competitor.
The company recently reported Q1 results for FY 2017. Revenue grew by 5% YOY. Adjusted EPS came in at 10% higher than Q1 FY 2016. Operating profit margin improved from 31% to 33%. Profitability is fantastic, as one could imagine.
Meanwhile, the dividend is gravy.
They’ve increased their dividend for seven consecutive years, which is about as long as the track record can be (considering their IPO in 2009). The five-year dividend growth rate is 28.5%, the payout ratio is under 60%, and the stock yields 2.33% right now.
Plus, they regularly pay special dividends. The last special dividend, which was $0.60 and paid late last year, was approximately 3% all by itself.
The only thing about the dividend is that the increases aren’t as clockwork as I’d like to see. The special dividends make up for some of this, but it’s an issue that I hope is worked out over time.
Looking at the valuation, the stock trades for a P/E ratio of a little over 24. That’s higher than the broader market, and it’s higher than the stock’s own five-year average, but it’s at a sizable discount to the industry average.
We’re talking about a captive customer base within an oligopoly structure. It’s tough for OTC Markets Group to do anything but print money looking forward, outside of some unforeseen major regulatory change to the markets.
Conclusion
These are all rather small companies. As such, unique risks and opportunities are present.
But I’m personally invested in all three companies. And they’ve been fine investments for me thus far.
All in all, I consider all three businesses to operate at levels much higher than most other companies. And with valuations that aren’t all that crazy relative to either the market or their own industries, I think we’re looking at above-average stocks at below-average valuations.
Full disclosure: I’m long all aforementioned stocks.
Do these ideas look compelling to you? Are you a shareholder in any of these companies? Have they performed well for you?
Thanks for reading.
Image courtesy of: Sira Anamwong at FreeDigitalPhotos.net.
Jason,
Nice write up! Refreshing to learn about some new investing ideas, especially ones that aren’t often talked about. I’m not familiar with these companies, so first order of business is to start “following” them on Seeking Alpha to get some updates in my news feed. Upon quick look from your writeup and Morningstar, AMNF looks to be in great shape.
In regards to the big stocks, however, what are your thoughts about the auto-insurance scandal with Wells Fargo? One scandal isn’t too hard to recover from. You get rid of the CEO and apologize to everyone. A second scandal is a little harder – I think they will have to clean out some of the board. Would also like to hear from Warren. I’ve been long WFC for a while, but if something else pops up in the next 6 months or year, I would be very fearful of serious brand damage. A stake-trimming might be on the table.
Guy
Guy,
Yeah, these are all way under the radar. But they’ve been some of the best investments for me thus far. AMNF is really due a valuation expansion, in my opinion.
WFC’s scandals aren’t the first bank (or business) scandals, nor will they be the last. But if you fear it’s going to materially impact the business, you’ll want to model that into the valuation and make a call from there.
Thanks for dropping by!
Cheers.
I think AMNF is due for a dividend increase soon or perhsps a special dividend, if not both. That may produce a short valuation pop. We’ll see- I love their underhyped and steady delivery of results. It reminds me of a company Buffett would fully own as he was building his empire several decades ago.
-Mike
Mike,
I agree. The first time I saw AMNF, a “younger Buffett” came to mind. Not the one who was buying cigar butts way back in the day, but the one that came about a little later. Armanino is a nice little business. Very consistent.
They’re due a dividend increase, but the capital allocation is obviously a little bit different right now. We’ll see how the rest of the year goes. I’m surprised not to see it at a P/E of 20+, but I’m glad I have the opportunity to buy more (if I so wish).
Best regards!
AMNF most reminds me of Buffett’s purchase of See’s Candy back in the early 70’s. If I remember right the purchase price was like $20 or 30 million but he mentioned that the ‘profits’ sent back by the company from then till now is like $1.5 Billion or so. That’s an amazing generation of capital. AMNF has been doing this for several years, increasing earnings and sending back an ever increasing chunk of their earnings back to owners for the past decade via dividends and they continue to deliver.
-Mike
Hello Jason,
thanks for sharing and digging these small caps…it reminds me that i have to do more research in that area (concerning german dividend small caps as US small caps). Until now i focused more on blue chips and REITs…
I like the Texas based company. Southside Bancshares looks very interesting with that div growth rate and 23 years of consecutive dividend increases. That’s a statement of reliability!
Best Regards,
DividendSolutions
DS,
There are definitely some smaller businesses out there that make for great long-term investments. After all, every big company was once a small company. Every business has to start somewhere. 🙂
Cheers!
JF –
Another great perspective, to dive deeper in the analysis and to not stop at the top 30 companies in the world. Being Italian – pumped about your AMNF holding and have been watching the stock for some time. Solid article and offering great perspective in the what “appears to be” an overall overvalued market – always diamonds there, but you have to dig deeper.
-Lanny
Lanny,
AMNF is really interesting. You get above-average growth, quality, and yield at a below-average valuation. The downside, though, is that the small size adds risk to the situation. So, of course, one just manages that risk the best they can. But these have been some of my best investments. So far, so good. 🙂
Best wishes.
This is timely for me. I just re-read (again) Peter Lynch’s classic One Up On Wall Street, and it has once again focused my attention on growing small caps. I especially like the fact that AMNF has less than 5% institutional ownership, which makes sense given that it’s too small for most institutional investors to be able to invest in it. I have to admit I’ve never heard of SBSI or OTCM, which I consider a point in their favor. I’m going to do some due diligence on all three.
Jim,
I’m glad I could bring some new ideas to the table. Have fun with the research! 🙂
Cheers.
Great writeup, Jason! Great to see some small cap dividends to provide that runway of growth. There’s nothing bad about diversifying your portfolio by company size, right?
So SBSI pays you in extra shares as well as cash dividends? I’ve gotta get some of that in my portfolio. Talk about having a runway to build even more dividends, right?
Sincerely,
ARB–Angry Retail Banker
ARB,
Indeed, market cap is just another way to diversify. I like big companies for the safety. But smaller companies can provide a tremendous amount of growth. It’s simple math.
SBSI does pay stock dividends. And that’s on top of the regular and special dividends. It’s been a great holding for me. 🙂
Cheers!
Hi Jason!
Thank you for this. Beeing from over seas it´s even harder to find these stocks but they are fun 🙂
Do you happen to know why SBSI chose to decrease the stock dividend to 2.5 % this year? Did they split it or did they cut it?
Best regards
Att Välja Lycka (“To choose happiness” in swedish 🙂
Att,
Happy to share!
I’m not sure what you’re referring to with the dividend. The company’s most recently declared dividend was $0.28, which compares to the $0.2341 paid this time last year. They haven’t decreased the dividend. They actually tend to increase it every quarter. I’d recommend looking through their IR page and going through the dividends. Not sure if special dividends are throwing you off, as they can vary.
Cheers!
Sorry, i´v must have been unclear. English can be hard 🙂
I reffered to the stock dividend and not the regular equity dividend. I couldn´t find the report where they declared that dividend but on the page
http://investors.southside.com/Dividend
they note that the stock dividend that was payed 27th of june was 2.5 % and all other years it was 5 % just as you wrote and I just thought you might know the reason but I will keep looking cous it looks like a nice little company. By european standards SBSI is at least close to midcap 🙂
Anyhow. You rock
Att,
Ahh, gotcha. Stock dividends are just like special dividends – they’re not guaranteed, nor should they be counted on to hit some kind of regular metric. The regular dividend continues to grow at a very high rate, and you’re getting a very appealing yield. The special and stock dividends are just gravy on top of that. 🙂
Cheers!