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These Small Stocks Pack a Big Dividend Punch

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If you need income from your portfolio and can't afford to live on the tiny returns that safe investments like Treasuries and bank CDs offer right now, buying dividend stocks gives you your best opportunity to meet your financial goals. But with so many investors interested in the well-known big-name dividend stocks that everyone's familiar with, you might be nervous about being the last to join a growing craze.

But that doesn't mean you should give up on dividend stocks entirely. Although they're somewhat rarer than their bigger counterparts, several smaller stocks carry attractive yields for shareholders -- and since they're further off the beaten path among dividend investors, these small stocks could give you a better chance at scoring the combination of solid income and great growth prospects that represent the holy grail for many investors.

Later in this article, I'll give you the names of several small dividend stocks with some great future prospects. But first, I want to take a look at why you don't often think of small-cap stocks when you're looking for dividend income.

Why most small stocks don't pay
When most investors think of dividends, they focus on big companies with mature businesses that generate huge amounts of cash. Since these companies have plenty of cash on hand and don't tend to be big innovators that have much need to invest their cash internally, they tend to reward shareholders with hefty dividend payments. In fact, over the years, these megacap companies often increase their dividends, making dividend growth the most compelling factor for their investors.

Small companies, on the other hand, often need their cash to plow back into their still-growing businesses. With most small companies struggling to grow amid competition and tough economic conditions, making sure they have access to the capital they need takes top priority. That makes most small companies less willing to give up their cash by paying dividends to shareholders. But when you do find small- and mid-cap companies willing to pay dividends, you know you've found something special.

Exceptions to the rule
As I did with international stocks last week, one great method I like to use to discover good prospects is to scan through popular exchange-traded funds for investing ideas. In this case, the WisdomTree SmallCap Dividend ETF (DES) uses a methodology that weights small-cap companies by their dividend payout. Here are the top stocks with the largest weighting in the ETF:


Trailing Dividend Yield

Weighting in ETF

Vector Group (NYSE: VGR  ) 9.5% 1.44%
UIL Holdings (NYSE: UIL  ) 5.4% 1.21%
Prospect Capital (Nasdaq: PSEC  ) 14.5% 1.06%
Medical Properties Trust (NYSE: MPW  ) 8.7% 1.02%
Potlatch (Nasdaq: PCH  ) 6.6% 1.00%
Solar Capital (Nasdaq: SLRC  ) 12% 0.89%
National Health Investors (NYSE: NHI  ) 5.6% 0.87%

Source: WisdomTree; Yahoo! Finance.

As you can see, these companies all pay out quite respectable dividends. But you'll want to note that many of these companies aren't directly comparable to ordinary dividend-paying stocks. For instance, Medical Properties Trust, Potlatch, and National Health Investors are all real estate investment trusts, which require dividend payments in order to obtain tax benefits. So since they're forced to pay dividends, they shouldn't get as much credit as companies that voluntarily pay them. Similarly, Solar Capital is a business development company, while Prospect Capital does private equity and mezzanine financing for up-and-coming businesses. Only electric and gas utility UIL and tobacco company Vector have ordinary operating businesses, and they reflect the fact that stocks in certain industries are much more likely to pay dividends than others.

That said, if it's income you want, these stocks can definitely deliver. And despite their relatively small size, they're likely to keep paying those dividends -- to a greater or lesser extent -- well into the future.

Win big by thinking small
Many of the conservative investors who tend to gravitate toward dividend investing avoid smaller companies in the belief that they're inevitably riskier. But small-cap dividend stocks can serve the dual purpose of diversifying your portfolio while still giving you the income you need. With two strong arguments in favor of them, you shouldn't count out small companies in your search for the best dividend stocks.

Dividend stocks are changing the rules of investing. To see some smart dividend stocks that could deserve a place in your portfolio, be sure to check out the Fool's free special report, "13 High-Yielding Stocks to Buy Today."

Fool contributor Dan Caplinger likes big rewards in small packages. He doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is its own reward.

Read/Post Comments (7) | Recommend This Article (66)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 26, 2011, at 6:47 PM, mrb1llz wrote:

    On 9/8 your article indicated VGR should be considered as a possible sell. I think you said the business model was broken. This article seems to contradict that thought. ?????

  • Report this Comment On September 27, 2011, at 7:54 AM, TMFGalagan wrote:

    @mrb1llz - I believe you may be confusing me with another writer. I looked back and didn't find an article where I'd talked about Vector in about the last six months.

    You'll find that different writers at the Motley Fool have different opinions about various stocks.


    dan (TMF Galagan)

  • Report this Comment On September 27, 2011, at 9:13 AM, Luoyu wrote:

    @DHMILL there is a whole lot more you can't spell other than the construction machines... Take your politics elsewhere. They put me to sleep and have no relevance to the article.

  • Report this Comment On September 27, 2011, at 11:29 AM, JayWright wrote:

    Thank you Luoyu. disrespect but take your political views to CNN or FAUX news sites. I need investment guidance, not policitcal opinions.

  • Report this Comment On September 27, 2011, at 11:47 AM, therom wrote:

    @DHMILL Personally, I am getting angry at you conservative types that take every aspect of business and finance to irrationally denegrate President Obama. Take your lies elsewhere and focus on the topic!

  • Report this Comment On September 28, 2011, at 6:21 PM, mrb1llz wrote:

    dan (TMF Galagan)

    You are correct - different author. My apologies.

  • Report this Comment On September 30, 2011, at 3:08 PM, TurboBuick wrote:

    Your comment that, "...Medical Properties Trust, Potlatch, and National Health Investors are all real estate investment trusts, which require dividend payments in order to obtain tax benefits. So since they're forced to pay dividends, they shouldn't get as much credit as companies that voluntarily pay them" is the most idiotic notion that I have ever heard. A dividend is a dividend and if a REIT or any other stock maintains a history of paying out high dividends they deserve equal credit (I as the recipient of numerous REIT dividends >14% over many years obviously couldn't care less what "the reason" is, as long as it is lawful and sustainable).

    BTW, for those readers who are interested in what those REITs are that I own and have paid those dividends consistently, they are: ANH, CIM, MFA, NLY, and RSO.

    Get your thinking together Dan! These companies are as respectable as any of the other you have mentioned and pay significantly higher dividends.



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