In seeking stocks that pay out decent dividends, most investors tend not to think beyond the blue chips.
That's a mistake. While many household-name stocks have cut their dividends in recent months and may well cut them further, many solid and dependable dividend stocks can be found among lists of small-cap and midcap names.
These smaller stocks often generate stronger growth in their dividend payments over time.
Lots of prospects
To come up with names that won't let investors down, Barrons.com identified 118 companies with market values between $800 million and $3 billion that have increased dividends for five consecutive years. To be considered, a stock had to pay a current dividend yield of at least 2.5%.We eliminated companies that were not profitable or not expected to generate profit growth. Financial companies were struck from the list. We also nixed companies with a debt-to-capital ratio over 60% and any companies paying out more than 60% of their annual earnings in dividends.
Companies with high payout ratios have a harder time protecting their dividends in earnings downturns.
Our selection criteria ended up weeding out several classic high-yield types of stocks, including real-estate investment trusts, master limited partnerships and many utility companies.
Among the stocks left standing were Universal (UVV, news, msgs), Owens & Minor (OMI, news, msgs), Flowers Foods (FLO, news, msgs), South Jersey Industries (SJI, news, msgs)ABM Industries (ABM, news, msgs). and
None of these stocks is a household name. In fact, only two sell-side analysts cover ABM, which provides cleaning services for industrial and commercial properties.
But all are well-established companies. In fact, the youngest, bread maker Flowers Foods, was founded in 1919.
Solid dividends harder to find
"It is getting hard to find stable, growing dividends, so you have to do a lot of hunting," says Howard Silverblatt, the senior index analyst at Standard & Poor's, referring to the rash of dividend cuts by big companies. "These days, small caps are an acceptable way to go."That notion flies in the face of some long-held biases on Wall Street. Investors typically like small-cap stocks for fast-climbing profits and highflying stock prices, not dividend income.
Unlike goliaths in the Standard & Poor's 500 Index ($INX) -- 72% of its stocks pay a dividend -- small companies often reinvest earnings to fuel future growth, rather than reward shareholders.
Still, dividend-paying stocks account for 56% of the S&P Midcap 400 Index ($MID.X) and one-third of the Russell 2000 Index ($RUT.X), including tobacco merchant Universal.
With a yield of 4.8%, Universal is the smallest company on our list. But it has the longest track record of dividend increases, having raised its payout every year since 1971.
"People believe there is a scarcity of small companies paying dividends," says Paul Magnuson, a co-manager of the Allianz NFJ Small Cap Value Fund (PCVAX). "It's one of the best-kept secrets in the small-cap arena."
What makes a safe dividend?
Of course, confidence in dividends has waned greatly.Since the start of 2008, 967 dividends paid by U.S. companies have been cut or suspended, according to Standard & Poor's.
In seeking dividend stocks, investors should focus on companies with strong balance sheets and enough free cash flow to fund the dividend payment. "In this environment, dividends are really important because they are a measure of quality," Magnuson adds.
One of the biggest companies on our list is Flowers Foods, with a yield of 3.3%. The company's first-quarter profits were hurt by commodity hedges that backfired. Still, profits could climb 12% this year, partly because of recent acquisitions.
In fact, the timing of Flowers' latest quarterly dividend increase -- a 17% boost May 29 -- "highlights considerable confidence in earnings growth," says Farha Aslam, a Stephens analyst.
The same can be said for hospital-supply wholesaler Owens & Minor and gas utility South Jersey Industries.
Compared with other picks, Owens' 2.5% yield looks modest. But the 127-year-old company raised its quarterly dividend by 15% in February. Also, dividends consume only one-third of Owens' annual profits, which are projected to grow 8% this year and 11% in 2010.
South Jersey, meanwhile, raised its quarterly dividend 10% in late November, well above the company's target. With a 3.5% yield, its payout consumes just 48% of profits, well below the industry norm. Those profits, meanwhile, should grow 7% annually over the next three to five years.
Other names, however, have had a harder time.
With a yield of 2.8%, ABM raised its dividend 4% in December even though office vacancy rates have cut into demand for janitorial services, which constitute 70% of the company's revenue.
Still, cost cuts and the acquisition 18 months ago of ABM's biggest rival will help drive profits up 19%, to $1.33 a share, during the fiscal year that ends Oct. 31, says Dave Gold, a Sidoti analyst. Meanwhile, Gold sees the century-old company generating $88 million in free cash flow this year, more than enough to cover its $25 million dividend payout.
"It wasn't a huge dividend hike, but it says a lot about their business," Gold says.