A number of investors are always looking for angles, tricks, or tips that will provide an edge. One such historical anomaly is stocks of smaller companies, have, over periods of time, provided higher returns than their larger-cap counterparts. Of course, this added return comes at the price of additional volatility, but for aggressive investors, a little more risk for more reward isn’t a major concern.
Conservative investors, however, would likely take umbrage at such an idea. For these individuals, the added risk simply isn’t worth the potential for higher returns. Even so, there are many ways to slice and dice a category of stocks. For example, one could simply limit his or her universe to small caps with low Beta coefficients (a measure of volatility to a broader market index). Although this alone would limit the investment options to stocks that are statistically less volatile than a broad index, it says nothing about the actual companies under consideration.
To get a better grasp of a small company while still leaving plenty of room for variety, dividend yield is another good addition to the screening process. Dividends can’t be faked or taken back, so they are often viewed as providing insight into a company’s finances and management. Although nothing is universal, searching for small company stocks with low Betas and relatively high dividends should create a good starting point for conservative investors desiring some small cap exposure.
We created such a screen using Value Line’s proprietary online system only to find that including Beta only shortened the list by a few names, suggesting that it didn’t add as much value as we had anticipated. As such, we altered the screen and simply looked for stocks with market caps between $100 million and $1 billion, and dividend yields above 3%. Consequently, the list was a little longer, but it was more varied, allowing for the question, “Is an 8% dividend yield actually worth the risk of a stock that is slightly more volatile than the market?”
Subscribers can replicate this screen using Value Line’s online stock screener, with or without the addition of Beta. Our non-Beta version of this screen turned up high dividend yielding small caps like Hot Topic, Inc. (HOTT) and A. Schulman Inc. (SHLM), offering a collection of risk/reward combinations, as well as solid investment prospects and varying dividend yields.
Hot Topic, Inc.
Hot Topic, Inc. is a mall-based specialty retailer of music-influenced and licensed clothing and accessories. It opened its doors in 1989 and currently operates 630 namesake locations, targeting both males and females between the ages of 12 and 22. The company also has roughly 150 Torrid stores, which sell similar apparel, but cater to plus-size females, ages 15-29. Stores are located in the United States, Puerto Rico, and Canada.
Although most retailers have been having some trouble circumventing the still-tough and uncertain economic environment, the same cannot be said for Hot Topic. The company boasted stellar first-quarter (fiscal year ended April 28th) results in which it posted a better-than-expected gain of $0.10 a share. It lost $0.19 per share in the same period last year. Same-store sales comparisons increased an impressive 7.5%, helping margins improve significantly.
Analyst J. Susan Ferrara believes that the company is well positioned going forward, and expects top- and bottom-line gains to remain solid. She looks for recent merchandise changes to continue to resonate with consumers, while earlier restructuring efforts bear further fruit, pushing margins higher. Longer-term, Ferrara looks for the Torrid franchise to become more significant to results.
The stock is Timely and offers solid appreciation potential out to 2015-2017. However, this issue gains greater appeal when the dividend is factored in. Indeed, HOTT yielded 3.4% at its recent quotation. That said, it should be noted that Ferrara’s full-year earnings estimate barely covers the current dividend. Any merchandising miscues or a prolonged economic downturn could spell trouble for this smaller retailer, despite what looks like a decent balance sheet.
A. Schulman, Inc.
A. Schulman, Inc. sells high performance plastic resins that are used as raw materials in its customers’ manufacturing operations. The company also purchases plastic resins for resale or to formulate proprietary compounds tailored to customer specifications. A Schulman acts as a manufacturer, merchant, and distributor.
Surprisingly, the company disappointed in the fiscal third-quarter (ended May 31st), posting earnings of $0.57 a share, pennies below last year’s mark and 12% lower than analyst Jeremy J. Butler’s expectation. Schulman had recorded a 45% share-net advance in the first half of the year. Sales slipped 7%, to $569.1 million, due to challenging global market conditions, with particular weakness in the Europe, the Middle East, and Africa (70% of revenues).
But nobody really seems too concerned at this time. The stock has actually traded up on news of the slip up and management modestly upped full-year guidance. True, Butler tempered his fourth-quarter and fiscal 2013 estimates to reflect ongoing demand weakness, but he has remained steadfast in his belief that better cost management and ongoing expansion into emerging markets will drive healthy annual earnings gains looking further out.
The current dividend (yields 3.5%) appears safe, too. Despite weakening a bit in recent months, finances remain decent according to Butler. Meanwhile, management reiterated that it expects cash flows to remain sufficient, and that there will be no changes to its current dividend and share-repurchase efforts. The income component adds a nice element to this otherwise fairly-priced offering.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.