Ask the average investor to name their favorite dividend-paying stock, and you normally get responses such as AT&T (NYSE: T ), Pfizer (NYSE: PFE ) and Procter & Gamble (NYSE: PG ).
I won't quibble with any of those names. These are time-tested businesses with above-average payouts that have served investors well over the years. They are also well-known and widely-held. You'll find them in most dividend-oriented mutual funds and exchange-traded funds (ETFs).
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Take T. Rowe Price Equity Income ( PRFDX ), one of the best large-cap value funds around (full disclosure, I hold it in my 401( K ) account). The fund is sitting on 2.9 million shares of AT&T and 8.9 million shares of Pfizer. Those stakes are worth $93 million and $375 million, respectively.
Keep in mind, the massive portfolio contains $20 billion in assets. So even a minor 1% position (the bare minimum to really move the performance needle) would require a $200 million investment. That precludes the fund from taking a meaningful stake in any small-cap stock (loosely defined as those with a market cap below $2 billion) without gobbling up more than 10% of the outstanding shares.
With chunks this size, the fund (and most others like it) invests mainly in mega-caps with market values of $50 billion to $100 billion or more. AT&T and Pfizer both have a market girth in excess of $200 billion. Believe it or not, that restriction is a handicap.
Just ask Warren Buffett. He has long lamented the fact that small businesses no longer make viable investment candidates for Berkshire Hathaway (NYSE: BRK-A ). Sure, they could be bought out, but their contribution to Berkshire's returns would be negligible. So Buffett and his trusted lieutenants must hunt for "elephants" instead.
Here's how he explains it:
Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.
Now, I can't promise you 50% annualized returns. But I will say that my High-Yield Investing newsletter scours the market for the same type of small businesses that Buffett favored when he was investing millions rather than billions... those with durable competitive advantages that generate hefty free cash flows.
In fact, we have an entire portfolio dedicated to these "undiscovered" high-yielders. That includes stocks like Aircastle (NYSE: AYR ), a small-cap aircraft leasing company. Don't let its stature fool you. Pound for pound, the business out-earns most others -- with a fleet of 261 jets earning a rental yield of 11.2% on their book value.
Aside from a yield that's three times the market average, AYR has also given my premium readers and I a total return just shy of 50% in 4.5 years.
Let's Screen For High-Yielding Small-Cap Stocks
Over the past few years, investors have shown a clear preference for growth over value and large-caps over small-caps. As a result, the small-cap value asset class has lagged, so bargains abound in this corner of the market.
Odds are (given that this asset class is widely neglected) your portfolio might lack exposure to small-cap dividend payers. With that in mind, today's screen was built to find a handful of suitable candidates. I went in search of stocks with market caps below $2.5 billion, above-average yields of 5% or better, sustainable payout ratios, and other attractive traits.
Here are a few of the standouts.
As always, the securities in the table above haven't been fully researched and shouldn't necessarily be considered portfolio recommendations. They simply meet certain screening criteria that make them worthy of a closer look.
Action to Take
While there are several intriguing names on this list, I'm currently looking at Triton International (NYSE: TRTN ). Triton merged with TAL International (one of my former holdings) not long ago, creating the world's largest shipping container leasing company. I'm a fan of this industry, in part because of the continued growth in global trade.
These 20- or 40-foot intermodal shipping crates are used to transport all types of goods from one country to another… electronics, furniture, frozen foods. Triton owns more than 6 million containers that are leased to various shipping customers -- generating consistent rental income. The average term of a new lease is seven years.
Triton has the #1 market position with eight of the world's top 10 carriers, leading to a strong container utilization rate close to 98%. Leasing revenues are currently running about $350 million per quarter, supporting a sizeable dividend yield of 6.5%.
With a discounted PEG ratio below 0.7, TRTN deserves strong consideration as a potential portfolio addition.