When it comes toinvesting , bigger isn't always better.
In fact, the opposite is sometimes true. Small-capstocks
outperformed large caps by an annual average of just more than 2%
from 1926 to 2006, according to the "Stocks,Bonds , Bills
andInflation " yearbook by Ibbotson Associates.
Though this is just an average, it's clear that overall, small
caps are proven top performers for the long term.
Small-cap stocks are defined differently amongbrokers .
Generally, these are companies with acapitalization between $300
million and $2 billion. Anything less than $300 million is
generally considered to be a micro-cap orpenny stock . Companies
with more than $2 billion fall into the mid-cap category. Large
caps are generally any company with more than $10 billion in
The benefits of small caps
Small-cap stocks providemarket outperformance during most economic
FidelityInvestments Chairman John Bogle conducted a
study revealing that small-cap stocks outperform during rising
interest rate environments. This is counterintuitive, but shows
that interest rates generally increase during times of economic
growth. Speaking of economic growth, small caps have a better
likelihood of growing rapidly than large caps. This in turn not
only leads to share price gains, butdividend raises.
[Combining dividends with growth is one part of the "Dividend
Trifecta" strategy Amy Calistri uses in herput , this strategy
multiplies the effectiveness of every dollar you invest. You can
And because small-cap stocks often trade for less than
larger-cap stocks, investors are able to purchase moreshares with
the same amount of capital. But the best thing about small caps is
that these stocks often pay attractive dividends. In fact, the
combination of small-cap stocks with historically increasing
dividends is a very powerfulinvestment strategy. So much so, that
this pairing spawned its very ownindex , the Russell 2000Dividend
The power of small caps combined with dividends
To be included in the index, stocks must have at least 10 years of
consistent dividend increases, be part of theRussell 2000 Index and
have a minimum daily tradingvolume of 500,000 shares. Of the 2,000
companies in the Russell 2000, only 63 qualify to be in the
Dividend Achiever Index. You can see from the illustration below
how the Dividend Achievers Index has outperformed the Russell 2000
Index since 2001.
Here are two stocks featured in the small-cap Dividend Achievers
Index that I particularly like right now:
1. Watsco Inc. (
This mega distributor of heating, air conditioning and
refrigeration equipment boasts amarket cap of $2.4
The company has paid dividends for the past 35 years and
currently yields 3% on apayout ratio of 45% of trailingfree cash
flow and 82% of trailingearnings . With a trailing 12-monthrevenue
of $3.3 billion, thestock has averaged a 13%return on equity (ROE)
for the past three years.
Most interestingly, the company paid aspecial dividend of $5 per
share in October 2012.CEO Albert Nahmad said the special dividend
shows management's confidence in the company and its continued
ability to generate free cash flow. I particularly like the fact
that institutions are the major holder of shares. BlackRockFund
Advisors holds 13% of the stock, while Fidelity Management and
Research holds 9%, as the top two shareholders.
As the U.S. housing recovery continues, many heating and air
conditioning systems could reach the end of their estimated life
span, causing a growing need for products and services this company
offers. Technically, shares have been uptrending since the end of
July 2012. Price hit resistance at $78 and has just pulled back
into the value "buy" zone. This consistent dividend payer is a good
pick with a $92, 18-month target price and an initial stop loss at
2. Owens & Minor (
Owens & Minor is a supplier of health care products and
third-partylogistics supply-chain management services. It serves a
network of 4,000 health care providers from 55 distribution centers
that are strategically placed across the United States.
This company boasts amarket capitalization of $1.9 billion and
has paid dividends since 1926. The dividends have increased during
each of the past 14 years. In fact, in the past five years,
dividends have increased by an average of 14.2%. The stock
currently yields 3% and has returned more than $200 million by way
of dividends to shareholders in the past several years.
The company has agross margin of 9.9% and anoperating margin of
2.5% with a net of 1.2%. It has a forward price-to-earnings (P/E )
ratio of 15.7, below industry average of 17.2. Its price-to-book
(P/B ) ratio is also lower than peers -- 1.9 vs. 2.8.
Despite the fact that Owens & Minor's 2013 forecast missed
estimates of just more than $2 per share with a forecast of $1.90,
I like that it just acquired Movianto Group for $158 million. This
recentacquisition is likely to facilitate an expansion into the
European health care market.
Technically, shares have bounced hard off of the Dec. 1, 2012,
lows, hitting resistance in the $30 range. Price has pulled back
into the value "buy" zone, creating a good buying opportunity. I
like this stock at current levels, with a $35 18-month target and
an initial stop loss at $29.
Risks to Consider:
Small caps can be very volatile. This volatility can be
negative and positive to the stock price. Always be sure to use
stops and position size properly when investing.
Action to Take -->
This year is shaping up to be abullish year for stocks in general,
and these two small caps are poised to benefit from the upwardwave
. As I said, buy Watsco between the $74 and $75 range for
aprice target of $92 in 18 months, and buy Owens & Minor
at current levels for an 18-month price target of $35.