5 Great High Yielding Small Cap Opportunities

 |  Includes: ALOT, CAW, ELSE, MOCO, WSTG
by: Tom Shohfi, CFA

Following my colleague John Femino’s recent article, I wanted to add my own contribution on some great high yielding equity opportunities in the lower end of the market capitalization spectrum. Long term investors can use a high, consistent dividend yield combined with a DRIP (Dividend Reinvestment Plan) to boost returns over time or provide a steady income stream. Plus, it's a widely held belief that small and micro capitalization value stocks are leading performers during market recoveries. Don’t just take my word, take Fidelity’s (though the analysis is via John Prestbo from MarketWatch).

Yet with dividends now being slashed on non-financials, how can we find safe dividend stocks? There are no guarantees, but companies that pay out less than 100% of earnings and have the net cash to cover a large dividend are capable of preserving high yields despite difficult economic times. If a company has little debt and can deliver cash to shareholders from both operations and its balance sheet, it is truly the widest margin of safety that an investor can hope to find. The five following stocks meet these criteria:

5 More High Yielding Small/Micro Caps Table (ALOT, CAW, ELSE, MOCO, WSTG)Click to enlarge

Despite having a really neat ticker symbol, Astro-Med currently trades well below its $7 tangible book value per share. The Rhode Island based company operates in three divisions, the largest of which is QuickLabel Systems (52.7% of revenue, 46.7% of operating income). Grass Technologies (24.9%, 26.1%), makers of neurophysiology monitoring devices, and its test and measurement group (22.4%, 27.2%), clients of which include Boeing (NYSE:BA) and Airbus, make up the other half of sales. It is an interesting product mix, but the combination has led to flat sales from 2007 to 2008. Astro-Med expects to report a net income drop of 33% from the prior fiscal year which is driven by sales from the Q4 falling 14% from 2007. The company announced preliminary earnings on February 18th and tempered investor expectations for the coming year.

Trading at a 12 month average volume of just over 5100 shares, liquidity has been an issue with this stock as it often is with many micro caps (including those in this list). In fact, ALOT stock had zero volume on 29 days over the past full year and traded more than $100,000 in dollar volume on only twenty of those trading days. However, with over three dollars in cash per share on its balance sheet and nearly six million dollars in free cash flow generated during the twelve months prior to November 2008, Astro-Med’s own liquidity is ample to sustain its dividend through deteriorating economic conditions.

Towering over this list at a yield of over 18%, consumer goods company CCA Industries will pay out its quarterly dividend of $0.11 on March 3rd, 2009. CCA sells a variety of brands in dietary supplements (Mega-T), skin (HairOff, Bikini Zone), hair (Wash ‘N Curl), nail (Nutra Nail) and oral care (Plus White). These brands are typically geared towards the budget conscious and should show some resistance during the consumer slowdown. While the company sells its products to the big three drug stores (Walgreen's (WAG), Rite-Aid (NYSE:RAD) and CVS), 44% of CCA’s 2008 revenue came from Wal-Mart (NYSE:WMT) and they could reap some tailwinds from the mega-retailer’s recession-proof sales machine.

So far, that thesis hasn’t held up. While the company reported a $0.20 profit for its fiscal 2008, the last quarter was challenging for the CCA. The company saw a 16% revenue decrease and posted a loss of $0.12/share. Like many larger branded companies, CCA management continued to invest in its brands during the fourth quarter recession which led to a larger loss from increased SG&A. But at only $2.36/share, CCA trades at 56% of its tangible book value. With zero long term debt on its balance sheet, valuation would indicate that there is a lot of downside presently priced into the stock.

At well under ten million, this “nano cap” is another stock with a great ticker symbol (not that a great ticker symbol has anything to do with being a great stock). Electro-Sensors is a very small company with less than fifty employees, but it has been in business for forty years and publicly traded since 1990. That’s not exactly a “fly by night” micro / nano capitalization company. Electro-Sensors has an impressive customer list. That may not be important for a large corporation, but for a company of this size, having many Fortune 500 customers provides significant reputational capital.

The company has two operating segments, but production monitoring products, which are effectively sensors and other industrial parts, make up 92% of its revenue and an even higher percentage of pretax income (see note 9 of its latest Q3 10-Q filing). The other operating segment of the company is a subsidiary called AutoData Systems, which produces OCR (optical character recognition) software and hardware. Despite the subsidiary’s small footprint in the overall company, the unit did see 31% revenue year-over-year growth during Q3 2008. The cyclical exposure of its core business is a large reason why the stock trades at a discount to net cash and securities, but Electro-Sensor’s last quarterly dividend of four cents was still paid out like clockwork on February 20th, 2009. With its current cash position, management can pay a $0.16 annual dividend out fifteen times over.

MOCON is the largest of these companies by market capitalization and, since it trades at close to twice tangible book value, is also the most expensive relative to its balance sheet. MOCON’s name comes from the original corporation called Modern Controls, Inc. that was formed in 1966 and renamed just two years later. Founded and still based out of Minneapolis, MOCON now designs and manufactures instruments that detect and analyze gases and trace compounds in the air. The applications for these products vary from homeland security, air quality as well as oil/gas exploration and over 60% of MOCON’s revenue now comes from outside of the United States.

Sales in Asia during Q3 2008 grew 32% year-over-year, offsetting domestic softness. The company has paid a dividend for 82 straight quarters and just increased its annual payout to $0.36/share, representing an increase of 12.5% from a year ago. MOCO has been public since 1989 and has not posted a loss in any full year since its IPO. With $15 million of cash on its balance sheet and trailing twelve month free cash flow of $3.7 million, their growing yearly dividend payout, which is roughly half of that FCF, looks relatively safe.

This is probably one of the worst named public companies that I’ve come across. Wayside’s single digit gross margins also aren’t the best that an investor could hope for, but considering its triple digit inventory turns, the company’s distribution system may have enough flexibility to handle declining sales (and they did decline 3.2% in 2008). WSTG’s three sub brands, Lifeboat Distribution, TechXtend and Programmer’s Paradise are all resellers of third party software and hardware. It appears that the loss of VMware resales through Lifeboat Distribution, which made up 17% of total sales, was a real blow to Wayside. The company is trying to move that division’s sales force over to Virtual Iron to pick up the slack.

Let’s face it, this is not really a technology company. It’s a sales force that sells IT products. As a tech guy, that’s not very interesting. However, as a value investor seeking high yields and solid balance sheets, WSTG’s $4 in cash per share doesn’t look quite so bad. Plus, management has a serious stake. CEO Simon Nynes, who has been with Wayside for over ten years and at the helm for just under three, owns 4.7% of the company. He’s also done a reasonable job managing SG&A expenses which is of crucial importance given those thin gross margins. Those expenses are now roughly half what they were before the last economic slowdown.

While these five stocks have passed the initial screening and my brief, preliminary analysis, I have not fully analyzed these companies. If you find any of them interesting you should perform additional research before investing.

Disclosure: The author does not have a position in any of the stocks mentioned in this article.