Many investors steer clear of dividend stocks because they figure that companies that make large payouts are shriveled-up, mature businesses that don't have any growth left in them. When you look at some blue chip dividend payers, it's easy to understand that argument, as some of them seem almost proud of their slow but steady growth and lack of volatility -- and excitement.
But not all dividend stocks are ready for the graveyard. A surprising number of small companies pay big dividends, and some of them still have the growth potential you'd expect from an up-and-coming business. Below, I'll name five of these potential dividend leaders, but first, let's take a look at why investors don't think of small caps when they're looking for dividend stocks.
Why small caps and dividends don't mix
It's no secret why so few small-cap companies decide to pay big dividends. Many larger companies have already hit their maximum potential and are milking their industries for everything they're worth for as long as they can. For their investors, the dividend is the story, and any other factors are less important.
Small companies, on the other hand, are typically hungry for capital to grow their businesses. To take advantage of growth opportunities, companies need cash on hand -- so paying that cash out to shareholders in the form of a dividend doesn't make maximum use of their capital. Only once a company starts generating so much cash flow that it can afford to channel some of it back to investors do dividend yields usually start becoming a factor.
Five small caps for dividend lovers
But a few small-cap stocks are different, offering hefty dividend yields in small packages. Here are five:
5-Year Dividend Growth Rate
|Tower Group (Nasdaq: TWGP )
|Daktronics (Nasdaq: DAKT )
|Meridian Bioscience (Nasdaq: VIVO )
|RadioShack (NYSE: RSH )
|Anworth Mortgage (NYSE: ANH )
Source: S&P Capital IQ. *Includes special dividend payment.
Interestingly, these companies are extremely diverse. Tower Group is a property and casualty insurer that operates predominantly in the Northeast. That was a tough place to be last year, as Hurricane Irene hit the region hard and gave the company its first quarterly loss since its 2004 IPO. Yet premium growth and a focus on expenses helped boost book value and keep the stock moving in the right direction.
Daktronics is best known for making big electronic displays for sports facilities. It paid a special dividend of $0.40 per share last year, and the company's free cash flow gave CEO Jim Morgan confidence in saying that he expects future dividend increases down the road.
Meridian Bioscience makes diagnostic test kits for detecting various types of diseases. The stock took a big hit last summer when Meridian said that full-year earnings would come in lower than expected, and since then, the company hasn't had much success in pushing its share price higher. However, regular quarterly dividend payments have continued at a level pace.
Many retail followers have given up RadioShack for dead, as it is struggling to make a place for itself in the dog-eat-dog world of electronics retail. Its emphasis on mobile devices may pay off for the company eventually, but a recent earnings warning makes it clear the company has further to go before it turns the corner.
Finally, Anworth is one of the smaller mortgage REITs in the market. Reliant on favorable interest rates, Anworth has seen great dividend growth since before the mortgage crisis hit, but payouts have actually fallen substantially from their mid-2009 peak.
These small companies show how dividend stocks aren't all alike. By considering the different attributes that various types of dividend stocks have, you can mix and match to find the right recipe for your investing portfolio.
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