By Serkan Unal
Empirical research by professors Eugene Fama from the University of Chicago and Kenneth French from Dartmouth's Tuck School shows that small cap and value stocks have outperformed other securities over the long run. In the period between 1927 and 2009, small-cap value stocks returned 14.9% per year, easily outperforming the broad U.S. stock market, whose returns averaged 9.6% per year. For the reference, returns on the large-cap value stocks averaged 11.8% per year over the same period. In an effort to achieve higher risk-adjusted returns, investors willing to accept a higher degree of risk should consider investing in small-caps value stocks that pay dividends.
David Dreman, the epitome of contrarian value investing, co-manages a portfolio of small-cap stock of undervalued, structurally-sound companies. A mutual fund carrying his name, the Dreman Small Cap Value Fund (KDSAX), consists of 124 holdings, including a number of positions that pay dividends. A closer review of the Fund, which has returned 19.5% over the past year (adjusted for load and expenses), reveals several dividend-paying stocks that should be considered by investors constructing value-oriented dividend portfolios with an objective to outperform the market. Here is a closer look at five such stocks with market capitalization between $1.0 billion and $4 billion, and dividend yields at or above 2%.
Washington Federal Inc. (WAFD) is a $1.7-billion savings and loans institution. It pays a dividend yield of 2.0% on a low payout ratio of only 25%. Its competitors East West Bancorp (EWBC) and Sterling Financial Corporation (STSA) pay dividend yields of 1.9% and 3.0%, respectively. Washington Federal's stock is attractive on valuation. It is priced below book value, with the price-to-book ratio of 0.9 versus 1.0 for its respective industry. Its price-to-cash flow of 9.7 is also lower than the industry's average of 10.5. With a trailing P/E of 12.3x, the stock is priced below the banking industry's average ratio of 14.1x. The stock's free cash flow yield is 6.6% and its ROE is 7.3%. In the same year-ago period, the ROE was lower at 5.99%. The bank has been reporting improving credit quality and higher capital adequacy ratios. It is growing through acquisitions-recently it completed the acquisition of South Valley Bank & Trust, which will be immediately accretive to its bottom line. There are some concerns about the banks high exposure to the real estate market, characterized by weak pricing. Washington Federal Inc. has a long-term EPS growth projection of 7.0%. It has no long-term debt. The shares are up 18.5% over the past year. Value investor Chuck Royce's hedge fund (check out its top picks) also owns a small stake in this stock.
Omega Healthcare Investors Inc. (OHI) is a $2.6-billion Real Estate Investment Trust [REIT] that invests in long-term healthcare facilities in the United States, focusing on nursing homes. The REIT's dividend (distribution) yields 7.7% on a payout ratio of 81% of adjusted funds from operations [FFO]. Omega Healthcare's main competitors HCP Inc. (HCP) and Ventas (VTR) yield 4.5% and 4.0%, respectively. Omega Healthcare raised its dividends, on average, by 9.4% per year over the past five years. This year, the REIT raised its FFO twice, with the latest FFO target for fiscal 2012 set at between $2.15 and $2.17 per share, above the analyst expectations for $2.14 per share. Healthcare has proven to be a recession-resistant sector. In the future, it stands to benefit from the higher demand for assisted and independent living facilities by the large Baby Boomer generation. Omega Healthcare has low leverage, stable cash flows, and exceptional liquidity as it does not have any near-term maturities. While its price-to-FFO of 10.5x is much lower than that of Ventas (at 16.6x), Omega Healthcare trades at a major premium to Net Asset Value [NAV] of 65.6%. An average health-care REIT trades at a 30% premium. Its high dividend adds its value appeal. Among fund managers, Jeffrey Furber (AEW Capital-check out its top picks) and billionaire Jim Simons are bullish about the stock.
CBL & Associates Properties Inc. (CBL) is a $3.5-billion retail REIT that invests in enclosed malls and open-air centers. It owns 165 malls in 29 states. The REIT pays a dividend (distribution) yield of 4.1% on a payout ratio of about 43% of FFO. Its competitors General Growth Properties Inc. (GGP) and Simon Property Group (SPG) pay dividends yielding 2.2% and 2.9%, respectively. CBL & Associates Properties is trading at 10.2x its projected fiscal year 2012 FFO, while most peers are trading at valuation metrics double the CBL & Associates'. Part of the answer is that CBL & Associates' debt load is higher than that of its competitors. For the reference, Simon Property Group is trading at a price-to-FFO of 19.6x with a smaller debt load. CBL & Associates Properties has seen rising FFOs over the past three years and higher occupancy rates, even in a recessionary environment. The outlook is relatively sanguine, given that the U.S. consumer continues to be resilient, and its position, on average, is expected to improve with the faster job creation. This will support a continued fair performance of retail REITs, including CBL & Associates Properties Inc. RenTech's Jim Simons is also a buyer of this stock.
Associated Banc-Corp (ASBC) is a $2.2-billion bank holding company providing banking and asset management services to customers in Wisconsin, Illinois, and Minnesota. Its dividend yields 2.5% on a payout ratio of 33%. The bank's competitors TCF Financial Corporation (TCB) and US Bancorp (USB) pay dividend yields of 1.7% and 2.5%, respectively. Over the past five years, Associated Banc-Corp's EPS contracted sharply, while its dividends were dramatically reduced in 2009. Since 2009, the bank's quarterly dividend has been on the sharp rise, increasing from $0.01 per share at the end of 2011 to $0.08 per share today. This year, the dividend was hiked by 60%. The bank is also returning cash to shareholders vis-à-vis share buybacks, with a recently approved plan worth $125 million. The bank's EPS growth is expected to average 8.3% per year for the next half decade. The bank trades below book value (0.8) at a discount to the banking industry (0.9). Its trailing P/E of 13.2x is below the industry's average of 14.1x. This stock has a high free cash flow yield of 12.2%. Its ROE is 5.9%. Recently, the ratings house Fitch upgraded the bank's outlook to positive, citing strong capital adequacy in conjunction with double-digit loan growth. Billionaire Ken Griffin of Citadel Investments holds a stake in this stock.
IdaCorp Inc. (IDA) is a $2.2-billion diversified utility company engaged in the production of electricity based on hydroelectric power. A company's subsidiary also operates in affordable housing and other real estate investments. IdaCorp's dividend yields 3.5% on a payout ratio of 47%. Its competitors Portland General Electric Company (POR) and Avista Corp. (AVA) pay dividend yields of 4.0% and 4.9%, respectively. Over the past five years, IdaCorp's EPS and dividends grew at average annual rates of 7.5% and 2.7%, respectively. For the next five, the company's annual EPS growth is forecast to average 4.0%. IdaCorp is attractive on valuation. Its price-to-book is slightly below that of its peers on average. With a forward P/E of 13.9x, the stock is trading below its respective industry's average ratio of 15.2x. At the end of the third quarter, value investor Jean-Marie Eveillard held as much as $192 million in this stock.