Smaller company shares have historically been the choice of investors looking for fast growth. A flourishing fledging firm can see its share price rise at a much faster rate than a larger counterpart, while large-cap companies are traditionally relied upon for regular income.
But fund managers are starting to look further down the market cap spectrum to find dividend payers. At a time when FTSE 100 firms have been slashing pay-outs, many smaller companies have been producing double digit dividend growth.
Not only has the FTSE Small Cap index jumped more than 17% over the past 12 months, but it is forecast to yield 3.1 per cent this year.
Andy Brough, manager of the Schroder UK Smaller Companies fund, says: “I have never known another time when there have been so many large-cap firms cutting dividends. Banks, miners and telecoms firms have all been slashing their pay outs and now there are concerns about the safety of oil and pharmaceutical company dividends too.”
Investors Turn Their Attention to Small Caps
As a result, many investors have turned their attentions back to small and mid-cap companies, after months of them being out of favour. These firms suffered in the wake of the Brexit vote as it was feared the UK economy could slow and domestically-focused businesses would be hit hardest. Rising inflation, a weaker pound and concerns about consumer spending have only added to those fears.
At the same time, large-cap companies have been given a major boon as their overseas profits have been boosted by exchange rates.
But Brough, whose fund is up 33.5% over the past year, says: “I don’t want to invest in companies which are just getting a one-off boost. I’m looking at the underlying earnings, because I don’t want a firm’s success to be dependent on currency movements.”
Instead he is looking for firms which are nimble and quick to adapt when there is change. He likes WH Smith (SMWH) which has successfully tapped into the trend for travel with outlets in train stations and airports. Shares are up more than 15% over the past year and yield almost 2.5%.
Photo-Me International (PHTM) is another firm which he says has reinvented itself. The company, whose shares yield 4.3%, has photo booths which can send pictures directly to the passport office and a thriving laundry business.
Look for Strong Market Positions
And Brough is not the only one finding opportunities among smaller companies. James Henderson, portfolio manager at Lowland Investment Company (LWI), looks for businesses with strong market positions and experienced management teams. Companies with these characteristics, he says, typically pay steady dividends, and many of them can be found in the small-cap space.
Henderson says: “Small and mid-cap stocks are ordinarily unloved by the income seeking portfolio manager but have the potential of being great yield stories. Because of their lack of liquidity, they are often under-researched, giving the savvy investor a greater chance of uncovering undervalued stocks.”
He likes Redde (REDD), which runs a fleet of courtesy cars and repair garages used by insurers. The £450 million firm is growing its market share and currently yields a meaty 6.6%.
Another favourite is suit retailer Moss Bros (MOSB), where new management, store refurbishments and a shake-up of the product range have seen the firm improve after years of underperformance – its shares yield 6.1%.
Lowland, which has a Silver Rating from Morningstar analysts, has returned 19% over the past year.
Opportunities are Being Overlooked
Iain Wells, manager of the Kames UK Equity Income fund, is also looking to smaller-cap stocks for reliable dividends. He says: “Some outstanding income producers have been overlooked because they are exposed to the consumer market, which is out of favour because consumer spending is expected to come under pressure as inflation rises.”
While Wells has been wary about domestically-focused stocks in recent months for that reason, he says there are exceptions. One of those is Card Factory (CARD), a greetings card retailer with some 800 stores across the UK and plans to open 50 more this year.
He also likes pub group Greene King (GNK) which has a track record for growing its dividend and currently yields 4.9%. While consumer spending is likely to fall, eating and drinking out is one of the more resilient areas where people are less likely to cut back, he says.
As investors look once more to smaller companies, Brough points out that the size of the business is not the most important factor. Firms operating in the same sector will face the same challenges regardless of their market capitalisation.
He says: “Larger firms are actually at a disadvantage because it is harder for them to adapt. At smaller companies, there are fewer people doing the decision making so they can change direction very quickly.”
