The hunt for yield will be a key preoccupation for investors over the next 12 months, but the game is changing from right under our feet.
While investors have been obsessed with stocks producing the fattest yields over the past year, I believe the focus will shift to “dividend growth” from “absolute dividend” in the coming months.
This means high-yielding stocks like Telstra and the big four banks are likely to play second fiddle to companies that are best placed to lift their dividend payments over the next few years as the latter group is primed to make further strong gains, particularly those at the smaller end of the market.
Growth investors (which include the majority of small cap investors) should stop sneering. This isn’t another story pandering to income chasers. If anything, growth investors should keep a keen eye out for companies lifting their dividends as dividend growth is a far more reliable indicator of a stock’s future performance than profit growth.
Eureka Report has compiled data from the 1,970 companies listed on the stock exchange and found that seven-in-10 companies that have lifted dividends consistently over the past three years have outperformed the All Ordinaries Index, with a stunning median return of 70.2% versus the 27.3% from the market benchmark.
What’s more interesting is that many of these companies did not fit into what many would consider “high-yielding stocks”.
In contrast, fewer than 40% of stocks that have generated consecutive earnings per share growth over the last three years have kept up with the gains on the broader market.
What’s more, it is a lot harder to find companies that can consistently lift dividend payments than those that can grow profits. Of the close to 2,000 listed companies on the ASX, fewer than 100 have lifted dividend payments every year since 2009-10, while 226 companies have generated consistent earnings growth over the period.
There are a few reasons for this. The fact that there are far more listed small companies that have yet to transition their businesses to a point where they are able to pay a dividend is one.
But the key reason, in my opinion, is because it is a much harder task to grow dividends than profits.
I am not saying growing profits is easy, but any decent small cap manager should be able to lift their profit from a relatively low base. On the other hand, paying a maiden dividend or increasing the payment is a lot riskier as managers are effectively issuing an implicit guarantee that they will at least maintain the payout, if not lift it, in the years to come.
Shareholders may be able to understand or forgive a miss in earnings during difficult times, but cutting dividends is seen as a cardinal sin. This is why managers deliberate at length before changing the company’s dividend policy, and they will only do it if they have confidence in their future.
This doesn’t mean managers will not artificially bolster their dividend to give their stock a temporary shot in the arm, but such cases are rare due to the risk of losing credibility in the market. This is why it is far more common to see companies massaging their profit numbers instead.
I believe most company boards are actively examining ways to increase dividends this August, particularly if they worry that their earnings will disappoint, because lifting dividends is the cheapest, if not easiest, way to support their share prices.
However, I am not expecting a wave of companies to lift dividends when they hand in their earnings report cards this month. What I do believe though is that companies with the ability to pay higher dividends will probably do so unless they are planning to make acquisitions – and I don’t think many will launch takeovers given the lack of confidence and risks involved.
Those that have already gone down this route have been rewarded. Packaging company Colorpak (CKL) rallied to a fresh record high of 85 cents when it raised its dividend by 7.7% to 3.5 cents, while debt purchase and collection agency Credit Corp Group (CCP) jumped over 1% to $9.60 in two days when it increased its payout by 28% to 37 cents a share. Both stocks are in the Uncapped 100.
I believe that companies well placed to deliver dividend growth are likely to enjoy a price-earnings (P/E) expansion, which means the market is willing to chase such stocks even if their P/Es are moving into what is considered “expensive territory”.
Over in large cap land, Resmed is a notable example. The stock surged to a record high of $5.45 on Friday thanks in part to its decision to pay a record quarterly dividend of US25 cents, up from US17 cents a share.
There is also an air of expectation around mining giants BHP Billiton (BHP) and Rio Tinto (RIO). Their cut back on capital expenditure in the face of volatile commodity prices means that they have the ability to increase dividends. If they don’t, things are likely to get ugly.
I think there is a similar expectation that is priced into the share price of Commonwealth Bank of Australia (CBA).
The only question left for small cap investors is how to pick the dividend dazzlers. Interestingly, consensus forecast is predicting that close to 40% of emerging companies on the Uncapped 100 will increase their dividend this month.
However, if I screened the stocks to find those in the strongest position to keep growing their dividends, the list would drop by more than half.
The stocks that are left are highlighted in the table below. These companies have a low payout ratio (the amount of dividends paid compared with profits booked) of 70% or less, are forecast to grow profits this year, and generate more cash than required to run their business and pay dividends.
While the list won’t bring much joy to the value investor as the stocks have all rallied sharply over the past year, a few of these stocks could be re-rating (P/E expansion) candidates.
Collins Foods (CKF) is one possible candidate, although just about all brokers covering the stock are rating it a “hold” as it is trading on a 2013-14 P/E of a little over nine times – which is in line with its five-year average.
The restaurant operator is struggling to turn around its struggling Sizzler restaurants, which account for around a quarter of total sales, with the balance coming from its Kentucky Fried Chicken fast food chain.
If management can convince investors that Sizzler is turning a corner in the current financial, it could justify a re-rating to around 12 to 14 times. This implies at least a 33% uplift to its share price, and even then, the stock would still be trading at a discount to its peers.
I recommend investors buy the stock in anticipation of the re-rating as its balance sheet can sustain further increases to dividends over the next three years, with analysts expecting dividends to rise to 12c a share by 2015-16 from 9.5c a share currently. The company’s financial year ends in April and it will release its half-year result on November 28.
Another Uncapped 100 stock that has the financial muscle to keep ramping up dividends over the next few years is engineering contractor LogiCamms.
The company is tipped to increase its full-year dividend by 1 cent to 9.5 cents for 2012-13 and that would put the stock on a gross-up yield of around 9%.
While LogiCamms is not immune to the slowdown in project spending, the recent acquisition of Independent Technology Holdings and its diversified customer base across mining, oil and gas, and infrastructure has given the company enough confidence to forecast “solid earnings growth” for 2012-13.
Even if LogiCamms’ earnings come in flat, its balance sheet is strong enough to support an increase in dividends given that the business is highly cash flow generative and its payout ratio is a modest 54%.
Think big, go smalls!
Brendon Lau does not hold shares in CKF or LCM.
Uncapped 100 - Australia's most interesting small cap stocks
|Small cap stocks covered by the Uncapped team|
|Code||Name||Rationale||Market cap ($m)||Total return 1-year (%)||Sector (GICS)|
|MTU||M2 Telecommunications Group||Amazing growth story and well run company. High free float and strong insto support.||1,157.56||98.56||Telecommunication Services|
|BRG||Breville Group||Well covered but good candidate for core holding due to good track record.||978.32||57.68||Consumer Discretionary|
|NHF||NIB Holdings /Australia||Only listed health insurer. Widely held. Good performer.||948.25||38.37||Financials|
|ARP||ARB Corp||Well covered but good candidate for core holding due to quality management.||940.81||36.66||Consumer Discretionary|
|MRM||Mermaid Marine Australia||Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.||850.86||42.14||Industrials|
|GEM||G8 Education||Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.||734.88||186.51||Consumer Discretionary|
|SRX||Sirtex Medical||A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.||694.83||70.28||Health Care|
|MMS||McMillan Shakespeare||One of the best performers since the GFC, but change to FBT rules is threatening growth.||681.15||-18.82||Industrials|
|AAD||Ardent Leisure Group||Widely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.||677.26||41.27||Consumer Discretionary|
|SGN||STW Communications Group||One of few companies able to benefit from online shift. Widely held and good insto support.||644.11||56.05||Consumer Discretionary|
|AUB||Austbrokers Holdings||The insurance broker is a strong performer. Widely held and well liked by small cap investors.||636.15||56.61||Financials|
|ACR||Acrux||One of the most successful Australian biotechs in recent history. Widely held by instos.||547.86||-12.16||Health Care|
|RFG||Retail Food Group||Owns a number of well know franchise brands. Widely followed by instos.||544.66||71.4||Consumer Discretionary|
|CCV||Cash Converters International||Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.||527.71||79.66||Consumer Discretionary|
|BDR||Beadell Resources||Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.||516.32||-5.07||Materials|
|SLX||Silex Systems||Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.||509.04||-25.62||Information Technology|
|BRU||Buru Energy||Substantial size but not often covered by press. Widely held with good insto support.||506.97||-42.01||Energy|
|NXT||NEXTDC||The cloud computing company is an IT sector darling. Fairly widely held and followed.||478.58||37.06||Telecommunication Services|
|SEA||Sundance Energy Australia||Analysts have a favorable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.||462.61||143.9||Energy|
|HZN||Horizon Oil||One of better regarded small energy stocks that doesn't receive much media attention.||444.38||24||Energy|
|CCP||Credit Corp Group||Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.||443.25||61.71||Industrials|
|AMM||Amcom Telecommunications||Well covered junior telco but good candidate for core holding.||438.98||57.47||Telecommunication Services|
|CWP||Cedar Woods Properties||Property developer with good ROE and earnings growth track record.||431.35||63.86||Financials|
|TOX||Tox Free Solutions||Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.||425.39||27.76||Industrials|
|BGA||Bega Cheese||Corporate interest in Australian food companies makes the cheese maker worth following.||417.63||75.58||Consumer Staples|
|MYS||MyState||Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.||399.16||48.43||Financials|
|FGE||Forge Group||One of the better performers in its industry. Good track record and potential core holding.||386.04||6.98||Industrials|
|UXC||UXC||Company has turned corner and enjoyed re-rating. What's next?||347.52||90.32||Information Technology|
|UNS||Unilife Corp||The developer of one-use prefilled syringes is close to an inflection point as the market is expecting the company to announce a major contract with a pharmaceutical giant in the coming weeks.||328.87||17.35||Health Care|
|MYX||Mayne Pharma Group||Sizeable generic drug maker with interesting board members.||325.4||106.25||Health Care|
|RKN||Reckon||Fierce competition for cloud base accounting software puts it in firing line.||323.72||18.55||Information Technology|
|RCR||RCR Tomlinson||Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?||318.5||56.41||Industrials|
|TGA||Thorn Group||One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.||309.71||34.14||Consumer Discretionary|
|MOC||Mortgage Choice||Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.||304.88||82.75||Financials|
|NWH||NRW Holdings||One of the better regarded mining & civil contractors with good track record in delivering on projects.||283.77||-58.47||Industrials|
|SPL||Starpharma Holdings||Noteworthy for its good pipeline of innovations. Well run, widely followed.||273.93||-34.58||Health Care|
|RIC||Ridley Corp||High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.||263.18||-11.55||Consumer Staples|
|AEU||Australian Education Trust||Well performing childcare centre property owner. Good yield story and outlook.||261.44||48.38||Financials|
|SIV||Silver Chef||Strong jump in the share price of the equipment financing group has attracted a good following.||244.2||153.7||Industrials|
|MXI||MaxiTRANS Industries||Transport equipment maker posted good interim result. Has appealing yield and growth.||241.03||113.89||Industrials|
|GID||GI Dynamics Inc||Largely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal shealth on diabetics.||240.96||-22.47||Health Care|
|BNO||Bionomics||One of the larger cancer treatment developers in this market.||238.44||133.36||Health Care|
|IMF||IMF Australia||Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.||237.79||30.93||Financials|
|AJA||Astro Japan Property Group||Strong leverage to Japanese economy makes this an interesting stock to watch.||227.85||26.06||Financials|
|SHV||Select Harvests||Noteworthy for turbulent past and exposure to soft commodity market.||218.36||206.1||Consumer Staples|
|CLH||Collection House||In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further||211.25||116.85||Industrials|
|DWS||DWS||Will be a big beneficiary if governments start spending on IT again.||209.13||9.11||Information Technology|
|GXL||Greencross||Acquisitive vetinary group. Good profit growth and share price performance, but gets little press.||203.45||142.34||Health Care|
|PFL||Patties Foods||Illiquid stock but has suite of well recognised consumer brands. Defensive yield.||196.78||-4.5||Consumer Staples|
|NAN||Nanosonics||A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.||192.56||50||Health Care|
|NWT||Newsat||Potential large cap if it can launch its own satellite in 2015.||190.2||-29.5||Telecommunication Services|
|IPP||iProperty Group||Worth watching as it is trying to be the REA Group of Asia.||188.45||11.83||Information Technology|
|DTL||Data#3||Well respected IT company that receives little press coverage.||185.92||5.61||Information Technology|
|IFM||Infomedia||Interesting tech play in the car parts market. Strong share price gain but gets little air play.||185.5||210.41||Information Technology|
|WBB||Wide Bay Australia||The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.||183.||-22.5||Financials|
|GXY||Galaxy Resources||Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.||177.43||n.a.||Materials|
|SFH||Specialty Fashion Group||In early stages of turnaround. Can the women's apparel retailer sustain the momentum?||170.13||86.18||Consumer Discretionary|
|HSN||Hansen Technologies||Operates in a high potential/growth industry but is not covered by press or brokers.||168.||18.45||Information Technology|
|CKF||Collins Foods||One of the few food franchise listed companies.||165.07||61.72||Consumer Discretionary|
|IMD||Imdex||Drilling company is well supported by instos and should benefit from any rebound in exploration activity.||164.17||-48.22||Materials|
|VOC||Vocus Communications||Telecom stocks are in favour but Vocus is one of the least covered||162.59||23.49||Telecommunication Services|
|MLB||Melbourne IT||A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.||152.17||20.8||Information Technology|
|TGS||Tiger Resources||Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.||145.08||-23.21||Materials|
|RCG||RCG Corp||The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.||140.86||61.18||Consumer Discretionary|
|TFC||TFS Corp||The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.||132.82||7.95||Materials|
|MCP||McPherson's||The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but its latest profit warning shows it's not immune.||130.37||-13.6||Consumer Discretionary|
|REX||Regional Express Holdings||Well run airline that is overshadowed by Virgin and Qantas.||129.91||9.97||Industrials|
|UBI||Universal Biosensors Inc||Well regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.||122.3||16.67||Health Care|
|AZZ||Antares Energy||Liquid with good insto support. Already in production with exploration upside in Texas.||118.58||14.81||Energy|
|NEA||Nearmap||A stellar performer with an Interesting business that offers high quality ariel maps to companies & government.||114.68||1045.16||Information Technology|
|ESV||Eservglobal||Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage||114.56||148.65||Information Technology|
|ACL||Alchemia /Australia||One of the few biotechs with revenue stream. Good pipeline of oncology treatments.||108.55||-33||Health Care|
|BGL||BigAir Group||The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.||108.22||77.59||Telecommunication Services|
|POH||Phosphagenics||Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.||107.15||-27.59||Health Care|
|LCM||LogiCamms||Strong price performance and reasonable valuation attracting interest.||104.63||47.09||Industrials|
|AMA||AMA Group||Good turnaround story but under the automotive services group is radar of most.||101.09||117.79||Consumer Discretionary|
|CLV||Clover Corp||One of the star performers in 2012. Operates in growing but relatively stable niche.||94.15||36.45||Health Care|
|SAR||Saracen Mineral Holdings||Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.||92.27||-62.2||Materials|
|JIN||Jumbo Interactive||Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.||87.54||69.48||Consumer Discretionary|
|DRM||Doray Minerals||Widely held by instos. One of the more favored gold explorers by brokers.||83.7||-22.05||Materials|
|PEN||Peninsula Energy||Widely held by instos and large free float. It's the only uranium miner on the list.||82.88||-12.5||Materials|
|WDS||WDS||Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.||75.27||8.79||Industrials|
|RUL||RungePincockMinarco||IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.||73.5||47.23||Industrials|
|AOH||Altona Mining||Noteworthy copper play with Xstrata pullout of Roseby project in Australia and the good ramp up of its Finnish project.||71.41||-50||Materials|
|CKL||Colorpak||The small cap packaging company has grown via acquisitions over past few years.||69.31||66.66||Materials|
|BOL||Boom Logistics||Crane hire group is riding out the downturn in construction. It's widely held by instos and is very liquid.||68.24||-42||Industrials|
|TAN||Tandou||The only direct equity exposure to cotton prices. Also trades water rights and receives little press.||67.29||34.08||Consumer Staples|
|CAA||Capral||An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose.||63.16||14.29||Materials|
|CUV||Clinuvel Pharmaceuticals||Interesting skin disorder treatment developer that has done reasonably well over past year||63.06||2.48||Health Care|
|TSM||ThinkSmart||Potential turnaround story worth keeping eye on.||55.18||78.95||Financials|
|LGD||Legend Corp||Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.||53.78||-15.57||Information Technology|
|KOV||Korvest||The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.||52.89||9.47||Industrials|
|UML||Unity Mining||Growing Tassie gold producer with high free float. Valuation looks compelling too.||50.54||-31.43||Materials|
|YTC||YTC Resources||Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.||49.91||-15.56||Materials|
|ISS||ISS Group||Good turnaround story from 2012 but the resource industry software developer under the radar of most. ISS has received a takeover offer after its inclusion in the Uncapped 100.||44.25||71.56||Information Technology|
|OTH||Onthehouse Holdings||Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a compeitive edge against REA.||40.68||20.33||Consumer Discretionary|
|NTC||NetComm Wireless||Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.||28.27||100||Information Technology|
|EBT||eBet||Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.||27.74||146.26||Consumer Discretionary|
|MBO||Mobilarm||Unique product that could change global maritime safety practices with its man-overboard location beacon.||17.97||100||Information Technology|
|PGC||Paragon Care||Emerging hospital equipment supplier that has been ignored by market.||14.51||59.52||Health Care|
|Source: Eureka Report, Bloomberg|