By Serkan Unal
In CNBC's guest blog, Mohamed El-Erian, the CEO and Co-Chief Investment Officer of PIMCO, recently warned that a U.S. recession is now more likely because of political quarrelling in Washington that risks aggravating "the country's unemployment situation and reigniting concerns about housing and household finances." This assessment of the U.S. economy warrants a reassessment of stock investment strategies. Despite the scheduled reinstatement of higher dividend tax rates as of next year, dividend stocks, especially the high-yielding ones should continue to appeal to prudent investors. Investors should focus on defensive plays that have stable business conditions which are less sensitive to economic or credit cycles and market volatility.
Based on the Russell 2000 Value-Defensive Index, including the value stocks that have lower price-to-book ratios and forecasted growth, here is a list of four defensive small-cap dividend stocks to safely navigate the markets in a recessionary environment. All picks have dividend yields above the 10-Year Treasuries and the Russell 2000 Index.
Cleco Corporation (CNL) is an electric utility company operating in Louisiana. It has paid dividends since 1935. The company's dividend currently yields 3.3% on a payout ratio of 48%. Over the past five years, Cleco's dividends grew, on average, by 7.6% annually. Analysts forecast the company's 5-year EPS CAGR at 3.0%. The stock is undervalued relative to its industry based on a trailing P/E of 16.1x versus the industry's average of 19.8x. With a forward P/E of 16.6x, this stock trades at a small premium to its industry (forward P/E of 15.3x). Cleco's ROE is nearly 12%. The utility's stock has a low beta of 0.47. This stock has outperformed the S&P 500 Index by a margin of 240 basis points since 1987, with dividends accounting for three-fourths of the company's total returns. As a testament to its sound financial performance, in November 2012, Cleco received an industry award for achieving the highest total shareholder return in the small capitalization category. Billionaire value investor Ken Fisher holds a small investment in the stock.
Rent-A-Center Inc. (RCII) leases household durable goods to customers on a rent-to-own basis. The company pays a dividend yield of 2.4% on a payout ratio of 27%. Rent-A-Center started paying a regular quarterly dividend in the third quarter of 2010. Since then, the quarterly dividend has increased 3.5 times. Analysts see the company's 5-year EPS CAGR at 10%, driven by growth in R-A-C Acceptance kiosks in traditional retail stores and international expansion in Mexico and Canada. The rent-to-own retailer is trading at a discount to its industry based on the price-to-book and price-to-sales ratios. Its forward P/E of 10.4x is well below its respective industry's at 17.6x. Rent-A-Center has a free cash flow yield of 6.1% and an ROE of 13%. It is trading at a long-term beta of 0.76. Fund manager Phill Gross (Adage Capital) is bullish about this stock.
WGL Holdings Inc. (WGL) is a natural gas utility company servicing customers in Washington D.C., Maryland, and Virginia. This utility holding company has been paying dividends for the past 160 years and has raised them every year since 1972. Currently, the utility's is paying a dividend yield of 4.0% on a payout ratio of 59%. Over the past five years, its dividends grew, on average, by 3.0% annually. Analysts forecast the utility's 5-year EPS CAGR at 5.6%, faster than over the past five years. WGL Holdings' price-to-book is 1.6, below the industry average of 2.0. Its forward P/E of 16.3x is lower than its industry's ratio of 18.2x. The company has an ROE of 11.2%. The stock is half as volatile as the overall market. Bryn Mawr Capital (check out its top picks) is a buyer of this stock.
Prosperity Bancshares (PB) is a Southwestern bank operating in Texas. The bank has raised dividends for 13 consecutive years. Its dividend is yielding 2.0% on a payout ratio of 27%. The bank's dividends grew, on average, by 11.6% over the past five years. Its 5-year EPS CAGR is forecasted at 7.5%. The bank's was able to retain profitability and raise dividends even during the financial crisis. Prosperity Bancshares has a price-to-book of 1.2, trading at a premium to its industry (with a price-to-book of 0.9). The bank's trailing P/E is 11.0x, making the stock cheaper than its industry on average (with a forward P/E of 14.5x). The bank has a high free cash flow yield of 7.8% and negligible long-term debt relative to equity. The bank's ROE is 8.7%, somewhat better than its respective sector's average. The bank's shares trade at a five-year beta of 0.8. Reputable value investors Ken Fisher and David Dreman have positions in the stock.