A Small Cap Income Alternative To Treasuries


Do you know what a 6-month U.S. Treasury bond is yielding right now? I do, 0.17%. That's right, less than a quarter of a percent. To make more than one percent investing in U.S. Treasury bonds you need to wait 5-years to get your money back - and for your patience Uncle Sam will pay you 1.58 percent. Wait 30-years and you're return skyrockets to 3.87 percent.

Let's see, what to do with that extra 1.58 percent on you capital. Well, if you buy $10,000 worth of 5-year U.S. Treasury bonds then in September of 2015 you will have $158.00. That's enough to take the family out to dinner - at least it is today. In five years who knows.

Why do I bring this up?

It's simple, because investing in essentially riskless U.S. Treasuries is the exact opposite of what this small cap letter is all about. Why does that matter? Because by showing you that the opposite of my advice is foolish, I strengthen my argument for what I'm about to tell you to do.

But if you don't want my advice, go buy U.S. Treasury bonds right now, sit back and get ready to feast on your profits in five years. Hope you're not hungry.

If you want my advice, read on. Because I'm about to tell you of an opportunity I just uncovered that is virtually guaranteed to pay you 9 percent over the next year. It's not as risk-free as a U.S. Treasury bond, but it's pretty darn secure. And who knows what's going to happen to the value of the dollar over the next five years. Waiting that long for a paltry 1.58 percent isn't exactly risk free. I'd even argue that you're not getting paid for the risk of inflation when you invest in a five year Treasury.

***First, let me put this discussion of yield in context with the aid of a few charts. This first one is the yield curve juxtaposed with an eight year chart of the S&P 500. You can see the yields that I just discussed are indeed accurate. But also note where the S&P 500 is right now.

My next chart shows the yield curve at the market's bottom on March 9 th of 2009 (the red line on the S&P chart marks the date of the yield curve). Notice anything different? Me neither. The yields on U.S. Treasuries during the market's collapse were essentially where they are now. Why? Because as investors flee to riskless assets yields completely collapse, ultimately approaching zero.

That's where we are today. The yield on any Treasury with less than 2-years to maturity is a pittance.

Now let's go back in time. The year is 2007, the summer is winding down, the market is rallying, real estate is still selling, and everything feels great. Except there is a problem...

The yield curve is beginning to get inverted. Very short-term Treasuries are yielding more than mid-term treasures - in other words, long-term debt is becoming less expensive than short-term debt. Savvy investors recognize that the yield curve is beginning to show a recession is imminent...

And so it goes - stocks plummet and the yield curve collapses.

And for equity investors, the buying opportunity of a lifetime becomes so mired in risk that they stay clear of the stock market altogether. What's the prevailing wisdom? Avoid risk, put any available money into a savings or money market account, or buy Treasuries.

One of the worst periods of wealth destruction scares people from taking advantage of one of the greatest buying opportunities in the last 30-years.

****If you're still reading, you're no doubt wondering what this has to do with small cap stocks. My answer to that question is simple.


When the market plummeted, small-caps led the way as investors fled from risk assets. And it was painful. But the reverse is also true - small caps tend to lead when an economy is recovering. In study after study, the results have shown this statement to be true.

Advisor Perspectives, a publisher of investing strategies for financial advisors, answers the question as to why small caps lead after a recession:

"According to Giuseppe Moscarini, an economist at Yale University and Fabien Postel-Vinay of the University of Bristol, employment growth at small firms is faster than at larger companies early in the recovery period because small firms are able to capitalize on the slack labor market typically associated with this point in the business cycle.

As a result, small- and mid-sized firms are better able to take advantage of the environment and produce stronger gains in both revenue and earnings.

Second, small caps generally experience steeper declines early in a recession due to a flight to safety that naturally occurs, resulting in oversold conditions and under-valued small- and mid-cap stocks.

Third, smaller companies tend to get a performance boost when mergers and acquisitions activity increases, which is common toward the end of a recession when valuations become more attractive and larger companies look for ways to grow their businesses."

Right now, investors are concerned that the economic recovery is not as robust as previously thought. They hear reports that earnings growth is slowing down, that revenue growth is not robust.

They are flocking back to Treasuries to decrease risk, and they earn a pittance of a guaranteed yield.

***But savvy investors believe in the recovery. They know that the pace of revenue and earnings growth from the bottom can't last forever. They know that slowing growth would come - and they knew that when it did they would start buying a select group of stocks. This group of stocks also pays a yield, but offers the additional potential for capital gains. I'm talking about dividend paying stocks, and I believe that now is the time to load up on stocks in this asset class.

Most people don't think of small caps when looking for dividend yields - and that's a mistake. Small cap companies that pay dividends are one the best performing groups of stocks over the long term. Between 1926 and 2004 small cap value stocks posted an average annual return of 15.9 percent - in comparison large cap growth stocks returned only about 9.26 percent.

I believe one of the best moves you can make right now in search of yield is to avoid low-yielding Treasuries and pursue small cap value stocks. Look for companies that have a solid track record of paying dividends, those with strong cash flow, and companies without excessive debt.

Whichever way the market goes from here, you should be able to collect that dividend, and potentially see some capital gains as well.

Now how can I say I can virtually guarantee you a 9 percent return?

I can because I've uncovered a small cap value stock that is paying over a nine percent dividend right now. This company went public in 2006 - and has paid a dividend every quarter since its IPO. Already it has paid out $5.36 in dividends, and it made it through the recession without cutting a single payment.

Right now this compay's quarterly dividend is yielding over nine percent when annualized - this is below the average yield of 10.3 percent since the company went public. That means that the stock price (remember a lower stock price increases the dividend yield, all else being equal) is lower than the historical average since going public. But that won's last, the stock will climb, and the opportunity for a 9-plus percent yield will dissappear.

Right now this company is a screaming buy. It generates cash flow from more than 7 businesses - each of which is a leader in their respective niche markets. It's one of the single best dividend paying stocks out there, in any market cap class.

If you'd like to learn more about this stocks, click here and you'll be able to sign up for a risk-free trial subscription to Small Cap Investor PRO . You can check out this company in my recent Special Report that includes two high yielding small cap value stocks. And if you don't like the service, cancel at no cost to you - but keep the research reports on these stocks.

Treasuries are yielding next to nothing, and select stocks are yielding over 9 percent. For value investors, the choice should be clear.

Let me know if you sign up, and if you like my report. My address is: editorial@smallcapinvestor.com .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Stocks

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