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Quality small and mid-cap stocks offer dividend hunters new prey

Friday, Apr 26 2013 by
5
Quality small and midcap stocks offer dividend hunters new prey

Following on from our Quarterly Strategies Review, we thought we’d take a closer look at the recent performance of our Guru income screens. As we’ve mentioned, blue chip dividend stocks were an appealing prospect for investors last year but the blistering pace of the market in the first quarter of 2013 has shaken the yield tree quite considerably. 

We track the performance of our strategy indices here and, as the following chart shows, income has done well overall as a strategy – but not perhaps in the way you’d expect. With surging prices and increasingly attractive yields, good quality smaller stocks have proved to be most attractive to investors of late. 

Sleeping Dogs 

For dividend hunters with a pure focus on high yield, going after the largest and theoretically safest stocks in the market have been for many months a useful solution to the limp returns on offer from cash and gilts. Throughout last year, one of the best known dividend strategies tracked on Stockopedia – Dividend Dogs of the FTSE 100 – put in a stellar performance as the index bounced off its spring lows and climbed through the year. Over 12 months, the Dividend Dogs delivered a 25.9% return (before dividends) versus 9.8% for the wider FTSE 100. 

We might have expected that strong performance to continue into 2013 but, intriguingly, it hasn’t quite been the case yet. Over the first three months of the year the Dividend Dogs strategy has turned a 5.41% profit against 8.7% for the index. Part of the reason seems to be that despite some strong performers, a small number of the top ten stocks qualifying as Dividend Dogs have seen their share prices dip slightly in 2013, among them RSA Insurance, Aviva and Royal Dutch Shell. For long term income investors, those wavering share prices may not matter. After all, if your hold period is (near to) forever, lower prices ought to mean higher yields for anyone buying up the shares now! 

Indeed, when Michael O’Higgins first presented his Dividend Dogs (or Dogs of the Dow) strategy, his primary focus was on picking large and (supposedly) reliable stocks because of their attractive dividends rather than their capacity to deliver capital growth. Still, while it’s a simple strategy to follow, one of the downsides is that its preference for size and yield doesn’t come with any other quality safety nets. So it’s interesting to observe that among all the income strategies tracked by Stockopedia, those delivering the best performance in Q1 (also ranking in the top ten performers across all our guru screens) are instead two that focus on quality and growth companies. 

Mid-Cap Quality + Yield = Outperformance 

In the Quarterly Strategies Review we noted that of all the guru models we track, those that outperformed in the first three months tended to have an emphasis on quality and growth factors. That pattern clearly makes its presence felt among the income screens too, with Winning Growth & Income (+16.85%) and the SocGen-esque Quality Income (+16.11%) easily outstripping the rest. For investors looking for a way to play the current trend towards good quality growth stocks, the dividend element could be worth watching. While the shares on these screens are generally smaller than the Dividend Dogs and their yields are lower, they aren’t that low. 

Winning Growth & Income is a dividend-focused strategy based loosely on the ‘Growth & Income Winners’ screen outlined in Kevin Matras’ excellent book, Finding #1 Stocks. He begins by looking for solid growth parameters then drills down to the best dividend payers of the group. In Matras’ version of the screen the primary filter is the US-focused Zacks Rank (a proprietary metric that tracks analyst forecasts) but we’ve  simplified this to just look for a positive change in analyst forecasts over the last quarter instead.  

Across the top 14 shares currently qualifying for the Winning Growth & Income screen, the average yield is a respectable 4.76%, with the top yielder being specialist savings company Hansard Global on 11.2% (although yields like that do tend to set the dividend cut alarm bells ringing!). With a couple of exceptions most have market caps of sub-£200 million, with the smallest being Animalcare and Vislink, so the interest for growth and small cap investors is plain. 

If fast growing small cap dividends aren’t your thing then the Quality Income screen should offer a more rigorous quality list of income stocks. This approach uses the Piotroski F-Score to seek out dividend payers that are at the top of their game in terms of financial discipline. Here, the market caps are naturally larger (mostly £1bn+) and so are the rolling yields but with the exception of utility group SSE, none of them are Dividend Dogs. Moreover, this screen offers more potential for sector diversification than the Dogs approach of simply picking the top 10 yielders in the FTSE 100. 

What Next? 

Recent analysis by Capita Registrars has pointed to some interesting dividend trends over recent months. In particular, the absence of one-off special dividends in Q1 pulled down the overall average pay-out, while the prospective 12 month yield for equities fell to 4.0% from 4.5%. 

Still, while some of the large cap-focused GuruModel income screens delivered muted performances during the first quarter, the principles behind high yield strategies still look robust. In our book, How to Make Money in Dividend Stocks, we go into detail about why income strategies have consistently delivered market beating returns and, even as the world economy starts to heal, we would expect them to continue to do well in what remains a yield starved world.  

Speaking of yield, those investors who may ordinarily have overlooked dividend payers in favour of good quality growth stocks, perhaps ought to look twice. The track record of capital growth from income stocks coupled with the yields still on offer from certain sections of the market suggests that it might just be possible to get two bites of the cherry. 

The table below shows the percentage capital gains of all the income GuruModel screens we’ve been modelling over the first quarter together with the average current and rolling yields that those screens are now showing. 

 

First Quarter Dividend GuruModel Performances

Screen

YTD Capital Gain

Avg Current Yield

Avg 1-Year Rolling Yield

Winning Growth & Income

16.9%

4.7%

4.7%

Quality Income

16.1%

3.7% (1)

4.4%

Large Cap Dividend Attraction

11.7%

3.5%

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3.8%

Best Dividends

10.7%

2.1%

2.3%

Dividend Achievers  

6.5%

1.9%

2.1%

Forecast Dogs of the FTSE 100

6.4%

5.4%

6.0%

Geraldine Weiss Lite Dividend

6.3%

1.9%

1.9%

Dividend Dogs of the FTSE 100

5.4%

5.6%

5.6%

PYAD

4.3%

5.5%

2.1%

(1)   Does not include proposed return of cash by Persimmon plc

 

Of course, do remember that our screens are just intended as a starting point for further analysis an inspiration – you can “fork” or tweak any of our income screens to add your take on the screening parameters, and our stock reports provide much more detail on each company to allow you to dig into the income profile.  

To try out our stock screening and fundamental analysis toolkit, you can sign up for a two week free trial here.


Filed Under: Dividend Investing,
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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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About Ben Hobson

Ben Hobson

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Strategies Editor at Stockopedia.  I make sure that Stockopedia is delivering the features that its members want to see.


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