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10 dividend ideas in small and mid-cap stocks

This article appeared in the October 2014 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Reliable yield can be found outside the top stocks - if you know what to look for.

Photo of Alistair McCorquodale By Alistair McCorquodale, Morgans

The first point for any investor when choosing a share is to consider whether you want to own part of the business. There are a number of small to mid-cap companies that are well run with good industry dynamics that could be considered for a portfolio. They may also pay a good dividend yield.

However, the main question when looking at an investment for the purpose of dividend yield is whether the high yield makes sense, given the context of the company. If so, owning a small or mid-cap share with a high yield may be appropriate for your portfolio and fit your overall investment strategy.

Understanding yield

The dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price; a calculation of the dividend per share divided by the share price at any point in time.

For an Australian taxpayer, any assessment of yield should include the grossing of franking credits attached to the dividends, to ensure comparability of income yield on a pre-tax basis across different companies and asset classes. Once an investor has confirmed their understanding of the numerator and denominator, they are in a position to assess the sustainability of the dividend yield.

Although many small or mid-cap companies are in a growth phase and therefore usually retain a large portion of their profits to reinvest in the business, there may be a number that, because of several factors, may have a relatively high and reliable dividend yield.

These factors may include:

  • The company's business model or the nature of the assets owned
  • The maturity and size of the industry in which the company operates
  • The point in the lifecycle of the product or the degree of specialisation of the service provided.

Part of any assessment of the sustainability of the dividend yield is the company's balance sheet, to ensure the debt level reflects its risk profile and that the cash flow statement shows the company is generating sufficient cash to enable it to pay the dividends. The key point is whether this financial health can be sustained into the future.

How yield from smaller companies differs from larger ones

The yield from an individual share is not a function, per se, of it size. But there are differences to consider when investing in large, mid-cap or small-cap stocks for yield. These include:

  • The company's size may provide an indication of the relative risk of its business model. A larger company may have more diverse operations in more markets and be a more mature business that has managed its growth over a period of time.
  • A larger company may have greater sharemarket liquidity, potentially lower price volatility and greater market coverage from the financial markets than a small or mid-cap company.

The market has provided a number of examples over the years of companies that had "high" dividend yields for a time before it was clear the yield was not sustainable. These include Qantas, Goodman Fielder and Pacific Brands.

With hindsight, the competitive pressures of the industries in which the companies operated and the management's ability to move their businesses through this competitive landscape, was the key assessment required when determining the sustainability of the dividend yield.

In these cases the current share price was a leading indicator that there was significant risk to the future level of profits and thus the sustainability of the dividend yield.

It is up to the investor, in consultation with their adviser, to determine the factors driving the high dividend yield, then determine its sustainability and make a decision on whether the share is appropriate for their portfolio.

Below is a table of 10 small and medium companies that income investors may want to consider.

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article).

Company ASX Code 2015 Forecast Yield
PACT Group PGH 5.58%
Cardno CDD 5.96%
AP Eagers APE 4.86%
Seymour Whyte SWL 5.10%
Ruralco RHL 5.40%
GUD Holdings GUD 6.29%
Hills Industries HIL 5.97%
Programmed Group PRG 6.55%
GWA Group GWA 5.20%
Retail Food Group RFG 5.14%

Dividend yield calculated as the 2015 forecast dividend per share (DPS) excluding franking credits, as provided by Morgans Financial Limited Research, divided by the share price at 23 September 2014. Source: Morgans.

About the author

Alistair McCorquodale is a private-client adviser at Morgans. Call (07) 3334 4501, or email for more information.

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