If you feel like you're falling behind financially, you're not alone. Frugality and a healthy household balance sheet may help some of us sleep better at night, but the returns on savings accounts are so low, they're practically negative in real terms -- depending on which inflation measure you like to use.
It's no wonder, then, that dividend-paying stocks have returned to darling status lately. Yields as low as 2% provide a huge bump up in what your spare money pays out. Although stocks are much riskier than cash in the bank, investor memory is short, and the last year's market rally remains fresh in many people's minds. Though you and I know that stocks aren't a no-lose proposition, they certainly seemed that way until the market turmoil of the past few weeks. If you can achieve both capital gains and a cash payout, why wouldn't you take advantage?
Then and now
I've been called crazy before for suggesting Fools buy anything now. With market pundits continually calling stocks "overvalued" by indexwide price-to-earnings metrics, and major uncertainty in energy, it might seem like a bad time to go dividend-hunting. But I've never much cared for wide-view market punditry; I prefer to concentrate on individual opportunities. Even in the fluffiest of markets, investors are always discounting certain stocks' potential. I'll share three of the better ideas I see right now, and tell you why they catch my eye.
For me, yield isn't the only thing to consider when looking at a dividend payer. I'm looking for long-term holds and a great likelihood of a growing dividend over that period. Growing dividends demand growing companies. That's why I'm not interested in securities like the high-yielding BP Prudhoe Bay Royalty Trust
Here's what I look for:
A business with plenty of room to grow
The easiest way to find these is to screen stocks by market cap. As the co-advisor of Motley Fool Hidden Gems, I usually restrict my digging to companies between $250 million and $2.5 billion, but when I'm looking for dividend payers that still have plenty of room to grow, I'm happy to consider companies up to $5 billion "small." However, that's as big as I go when I'm looking for this kind of dividend payer.
Why? Huge companies have often exhausted much of their growth potential. A company that can double or triple in value over the next five years, and increase its dividend along the way, is much more likely to pay me two ways, with capital gains and an expanding dividend.
That's why I'm often lukewarm on buying even a great company like Altria Group
A business with a proven record of growth and profitability
The recent recession makes gauging growth a bit tough, but in general, I like to see the top line growing at least 10% per year over a rolling three- to five-year period. It should (but doesn't) go without saying that I want to see an increase in profits as well -- and not just net profits. I want to see free cash flow (FCF), which I define as cash from operations less capital expenditures, steadily increasing as well. Corning
I like to see a company covering its dividend with cash produced from operations. I know that with interest rates as low as they are, many companies are bulking up on debt, and some of them are using that debt to pay dividends. While I understand the arguments for doing so, it's not an approach I like for the long term. I prefer companies that are committed to paying as they go, not only because it avoids balance-sheet uncertainty, but also because I like the fiscal conservatism that underlies such a decision.
I grew up watching wrestling, but my love of body slams and sleeper holds can't keep me from throwing World Wrestling Entertainment
The ones to watch
I've watched Healthcare Services Group
Grupo Aeroportuario del Sureste
Foolish final thoughts
There's no one way to invest, and investors interested in income from their stocks don't have to settle for giant, stagnant cash producers. If you're not ready to add any of these to your portfolio, consider adding them to My Watchlist, our free service that lets you keep track of the story, and provides personalized news updates on the stocks you care about most. And let me know what your favorite small-cap dividend payers are in the comments below.
Grupo Aeroportuario Del Sureste is a Motley Fool Hidden Gems recommendation. Motley Fool Options has recommended a modified stock repair position on Guess?, which involves owning the stock and buying and writing various call options. The Fool owns shares of Altria Group and Guess?.
At the time of publication, Seth Jayson owned shares of Guess? but had no position in any other company mentioned here. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool has a disclosure policy.