Three solid, high-yielding small caps

Source: Datastream

I also published a list of 18 slightly lower quality small cap yield stocks last year, which had failed one of my screen's tests but passed the rest. Interestingly, these stocks outperformed the higher quality stocks and when the performance of this portfolio was added to that of the five core stock picks, the combined total return was a whopping 43.1 per cent. Perhaps this stronger performance should not be too surprising given that investors have increasingly been willing to buy into lower quality situations as confidence builds. But the high quality stocks did mark themselves out based on the consistency of their performance (see first five stocks in accompanying table) with all delivering a good return. By contrast, the lower quality picks put in widely varying performance ranging from a gargantuan 161 per cent return from Jarvis Securities to a 14.6 per cent negative return from Asian Citrus.

Last year's high yield small caps

Source: Datastream

The impact of such a strong run by small caps, and especially high-yield stocks, is that the income on offer from this part of the market is now a lot less attractive than it was a year ago. Indeed, for last year's screen I eliminated stocks with a yield below 4 per cent, which effectively meant targeting the top third of yields. This year, only one fifth of the 464 dividend paying small caps that I screened boast a yield of over 4 per cent and only one of those passed all of the screen's other criteria. I've therefore moved with the times and lowered the bar. Stocks still need to be among the third best yielders out of all those stocks paying dividends, but this now equates to a payout of 3.17 per cent or more. It's worth noting that the screen uses historical dividend data but also looks for indications of dividend growth, so actually the future payout should be better than what was on offer last year. The criteria the screen looks at to assess dividend prospects are:

This year only three stocks passed all the tests set down by the screen and these are looked at in further detail below in order of highest to lowest yield. I've also included a table of the 12 stocks that passed the yield test and met all but one of the other criteria.

THREE HIGH-YIELD SMALL CAPS

S&U

It is motor financing business Advantage that is currently spearheading growth at S&U (SUS). The division increased its profits by almost a half in the first half thanks to very strong demand. The withdrawal of mainstream lenders from this part of the market puts the company in a very strong position as it is able to pick and choose which customers to extend finance to, which keeps down the level of bad loans. The company has also launched new products that have the effect of increasing the credit quality of borrowers. Ironically, the improving economic mood and the possibility of a return to more normal service by the big banks does present a potential increase in competition down the track for S&U. But from the company's perspective, the industry as a whole continues to look reassuringly dysfunctional at the moment.

Improving economic conditions do have the potential to boost S&U's home lending business, but economic recovery will in all likelihood need to feed through to rising real disposable incomes first. For the time being, this operation continues to find it hard going with receivables dropping 2 per cent in the first half. Strong forecast earnings growth should continue to underpin the dividend though and the first half payout was hiked by an eye catching 17 per cent.

Last IC view: Buy, 1,428p, 25 Sep 2013

XP Power

XP Power (XPP) was one of our runner-up stocks in last year's screen and produced a stunning 68 per cent total return in the following year. Nevertheless the yield has remained at a level that allowed it to qualify for this year's screen with flying colours. There are a number of factors working in XP's favour at the moment and this is the third screen that has highlighted the stock this year. Over recent years, the group has refocused the business away from distribution to higher-margin manufacturing for niche growth markets. What's more, the headwinds from a sluggish economy which had been holding back growth have now started to ease with recent updates on the order book looking encouraging.

These positive trends for the trading outlook are enhanced by the fact that the company has a large fixed cost base, so increased sales should have a disproportionately large impact on profit. The company is also very cash-generative and has a strong balance sheet, so any improvement in performance can be expected to feed through to enhanced dividend growth, which broker Investec is already foreasting will come in at 10 per cent this year and 12 per cent next year, giving a yield of 3.5 per cent rising to 3.9 per cent in 2014. In fact, based on current trading, the broker thinks there is a good possibility it will soon be upgrading forecasts for 2014 and beyond.

Last IC view: Buy, 1,325p, 29 Jul 2013

Portmeirion

China company Portmeirion (PMP) has had a rather testing year so far, with sales dropping in the US and UK albeit set off by particularly strong revenue growth in South Korea, which now accounts for nearly a third of sales. The group has also been hit by anti-dumping duty on imports from China where it sources many of its products. But the longer-term outlook looks pretty good based on prospects for development of the business overseas and the launch of new products. Indeed, brokers believe the lost ground in the first half can be made up in the second half from strong Christmas orders and cost savings. Sales of commemorative china to mark the birth of Prince George should also help make up for last year's first-half Diamond Jubilee boost. The company's earnings should also be enhanced by the recent purchase of a warehouse for £3.9m.

However, the dividend is the stock's key attraction. The company has a 20-year record of unbroken dividend growth and upped the payment by 11 per cent at the half-year stage. There is decent cover for the payment and the company is sitting on net cash. Broker Panmure Gordon also points out that the company is valued at a noteworthy discount to its closest rival Churchill China, which based on Bloomberg consensus forecasts, trades at 15 times the next 12-months expected earnings.

Last IC view: Hold, 640p, 1 Aug 2013

The rest

Source: S&P CapitalIQ