Small-caps with big yields offer steady returns

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What are we looking for?

Small-cap Canadian stocks that offer a big yield punch.

Small-cap dividend payers

Craig McGee, senior consultant at Morningstar Canada, recently took a closer look at returns for component stocks on the S&P/TSX Small Cap Index. He noted that since the beginning of 2000, this small-cap Canadian benchmark has generated average annualized total returns (including dividends) of 4.4 per cent.

However, he was curious to see how the returns have differed between companies on the index that pay a dividend (or other form of cash distribution), and companies that don't. Using data from Morningstar's CPMS data services, he split the index into two separate portfolios – S&P/TSX Small Cap dividend-payers, and S&P/TSX Small Cap non-payers – and back-tested them from January, 2000.

Mr. McGee weighted the stocks in each portfolio by market capitalization, and rebalanced the two portfolios on a monthly basis to adjust for any changes in dividend policy.

More about Morningstar

Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its investment research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.

What we found

The accompanying table shows the 20 S&P/TSX Small Cap stocks with the highest dividend yield (based on expected payouts over the next year). To screen out companies whose level of payments look hard to sustain, Mr. McGee excluded companies with a payout ratio (dividends as a percentage of operating cash flow) of more than 85 per cent. For diversification, no more than four stocks per sector were allowed.

There's good reason for focusing on the dividend payers. Mr. McGee found that since the start of 2000, his small-cap dividend-payers portfolio cranked out an annualized total return of 11.7 per cent, compared with just 2 per cent for the non-payer portfolio.