Small-cap investing entails higher risks than investing in large-cap blue chip companies, but there are many ways that your peers are beating the market in this space. Still, for dividend investors, investing in small-cap stocks with an impeccable record of dividend growth that stretches over several decades provides a degree of safety and regularity of ever-increasing income flows. Like their large-cap counterparts, some small-cap stocks boast consistent earnings power through all economic cycles and generate strong cash flows that provide for nearly guaranteed dividend increases year after year.
Among these kinds of small-cap stocks, there are five with more than 45 years of consecutive annual dividend increases.
Let’s take a look
California Water Service Group (NYSE:CWT), the third largest investor-owned water utility in the United States, has raised dividends for 45 consecutive years. The stock yields 3.2% on a payout ratio of 70% of its current-year EPS estimate. Over the past five years, the company’s dividend grew at an average CAGR of 18.5%, more than double its EPS CAGR, which averaged 7.7% annually over the same period. The company operates in the areas that are experiencing relatively fast population growth, which bodes well for its organic customer growth. Its business is mainly regulated, so the company is awaiting a rate decision on its 2012 General Rate Case filed back in mid-2012, envisioning rate increases of 19.4% for 2014, 3.0% for 2015, and 2.9% for 2016.
The company also requested approval to invest some $480 million in utility plant. Analysts forecast the company’s EPS growing at an average CAGR of 6.0% for the next five years. The company has a ROE of 10.6%. In terms of valuation, California Water Service Group (NYSE:CWT) is pricey, trading at a forward P/E of 22x, well above the forward multiple of its respective industry. Last quarter, the stock was popular with hedge fund manager Israel Englander, who boosted his California Water Service Group (NYSE:CWT) share holdings by 276% to about 200,000 shares.
ABM Industries, Inc. (NYSE:ABM), a facility management services company, has raised dividends for 45 years in a row. It yields 2.8% on a payout ratio of 43% of the current-year EPS estimate. Its dividend grew at an average CAGR of 3.8% over the past five years, slower than the company’s EPS growth of 5.8% annually over the same period. Since 2000, the company’s revenues have more than doubled—reaching a record high last year—while its adjusted EBITDA has nearly tripled. Over the same period, ABM’s dividend has increased by 87% cumulatively. In the 2010-2014 period, the company aims to capitalize on outsourcing, vertical expertise, and consolidation of services. It is also pursuing expansion through accretive acquisitions.
While ABM Industries, Inc. (NYSE:ABM)is targeting double-digit adjusted EBITDA growth, its adjusted EBITDA and EPS growth has been modest over the past five years. Analysts see weak EPS growth going forward, forecasting a long-term EPS CAGR of only 1.0% for the next five years, suppressed by weak government spending. Still, the company recently provided FY2013 guidance for adjusted income from continuing operations ($1.35 to $1.45 per diluted share) that exceeded the analyst consensus estimate ($1.36 per diluted share). ABM Industries, Inc. (NYSE:ABM) is trading at 15.2x forward earnings, below its respective industry. The stock is one of holdings in small-cap value investor David Dreman’s portfolio.
SJW Corp. (NYSE:SJW), a holding company for water utilities in San Jose, California and Texas and a commercial buildings and undeveloped land business, has raised dividends for 45 consecutive years. At present, the stock yields 2.8% on a payout ratio of 55% of the current-year EPS estimate. Over the past five years, the company’s dividend grew at an average CAGR of 13.5%, faster than the 8.5% annual rate of the company’s EPS growth over the same period. While the company’s EPS growth has been robust, analysts expect an even faster rate of EPS growth for the next five years, averaging about 14.0% annually.
Warren Buffett never mentions this but he is one of the first hedge fund managers who unlocked the secrets of successful stock market investing. He launched his hedge fund in 1956 with $105,100 in seed capital. Back then they weren’t called hedge funds, they were called “partnerships”. Warren Buffett took 25% of all returns in excess of 6 percent.
For example S&P 500 Index returned 43.4% in 1958. If Warren Buffett’s hedge fund didn’t generate any outperformance (i.e. secretly invested like a closet index fund), Warren Buffett would have pocketed a quarter of the 37.4% excess return. That would have been 9.35% in hedge fund “fees”.
Actually Warren Buffett failed to beat the S&P 500 Index in 1958, returned only 40.9% and pocketed 8.7 percentage of it as “fees”. His investors didn’t mind that he underperformed the market in 1958 because he beat the market by a large margin in 1957. That year Buffett’s hedge fund returned 10.4% and Buffett took only 1.1 percentage points of that as “fees”. S&P 500 Index lost 10.8% in 1957, so Buffett’s investors actually thrilled to beat the market by 20.1 percentage points in 1957.
Between 1957 and 1966 Warren Buffett’s hedge fund returned 23.5% annually after deducting Warren Buffett’s 5.5 percentage point annual fees. S&P 500 Index generated an average annual compounded return of only 9.2% during the same 10-year period. An investor who invested $10,000 in Warren Buffett’s hedge fund at the beginning of 1957 saw his capital turn into $103,000 before fees and $64,100 after fees (this means Warren Buffett made more than $36,000 in fees from this investor).
As you can guess, Warren Buffett’s #1 wealth building strategy is to generate high returns in the 20% to 30% range.
We see several investors trying to strike it rich in options market by risking their entire savings. You can get rich by returning 20% per year and compounding that for several years. Warren Buffett has been investing and compounding for at least 65 years.
So, how did Warren Buffett manage to generate high returns and beat the market?
In a free sample issue of our monthly newsletter we analyzed Warren Buffett’s stock picks covering the 1999-2017 period and identified the best performing stocks in Warren Buffett’s portfolio. This is basically a recipe to generate better returns than Warren Buffett is achieving himself.
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