By Serkan Unal
In our recent articles, we talked about low-volatility strategies as successful ways to outperform the market over the long run, as supported by historical evidence. Our research focused on large-cap and mid-cap stocks with the lowest realized volatility over the past 12 months, as measured by the standard deviation (variability of returns) of the stocks' daily price returns over the noted period. In addition to stocks with market capitalization well above $2 billion, there is a number of stocks below or around that threshold with low variability of returns over time. Based on the S&P SmallCap 600 Low Volatility Index, below is a closer look at five small-cap dividend stocks in the S&P SmallCap 600 index with the lowest historical volatility over the past 12 months, as indicated by the stocks' weights in the noted low-volatility index.
Even though these are small-cap stocks, low volatility of their returns suggests that they could be less volatile than the overall market, while the stocks' dividend payouts may serve as an additional cushion against the stocks' downside. However, all five featured equities are utility stocks. The pattern of observed outperformance of low-volatility strategies is primarily tied to diversified equity portfolios. Moreover, investors should recognize that the historical performance does not guarantee future results.
ALLETE, Inc. (NYSE:ALE), a diversified utility company, has the lowest observed volatility over the past 12 months among the S&P SmallCap 600 stocks. The company has a dividend yield of 3.9%, payout ratio of 69% of the current-year EPS estimate, and five-year annualized dividend growth of 2.0%. The stock's annualized total return over the past five years averaged 7.8%, while its price gain over the past 12 months was 20.4%. ALE has been growing its EPS at an average CAGR of 5.8% since 2010, above its targeted long-term EPS CAGR of 5.0%. The company's midpoint 2013 EPS guidance range of $2.58-$2.78 suggests flat-to-7.8% EPS growth this year. The company is heavily investing in new production capacity, including a significant focus on low-cost renewable energy such as wind, which could drive a 35% expected total rate base growth in the 2012-2017 period. Its outlook for the electricity demand is positive due to initiation of several large-scale industrial projects. Moreover, the company's cash flow may improve as the company monetizes its Florida real estate in order to eliminate a drag on earnings and provide funding for growth initiatives. In terms of valuation, ALE is trading at 17.9x forward earnings, above its respective industry. Last quarter, among hedge fund managers, Polaris Capital's Bernard Horn, a value investor, reported owning more than 980,000 shares in this company.
UNS Energy Corporation (NYSE:UNS), an electric power utility serving 630,000 customers across Arizona, is the second least volatile stock over the past 12 months among the S&P SmallCap 600 stocks. It has a dividend yield of 3.6%, payout ratio of 65% of the current-year EPS estimate, and five-year annualized dividend growth of 27.9%. The stock produced an annualized total return of 18.6% over the past five years. Its price gain over the past 12 months was 35.6%. However, the stock is currently trading at a lofty forward multiple of 18.3x. UNS's strong performance is tied to its robust dividend growth. Last quarter, the company beat analyst estimates of both revenues and earnings. Still, its full-year 2012 EPS was below that in the year earlier due to after-tax loss related to the partial write-off of a transmission project and net income reduction due to an unscheduled plant outage. The company has not provided guidance for this year, due to uncertainty over its Tucson Electric Power's pending rate case. Analysts generally expect the utility company to grow its EPS at a long-term CAGR of 8.0%. As the company remains dedicated to maintaining its dividend payout range of 60%-to-70% of EPS, any future EPS growth could easily translate into higher payouts. As regards hedge fund interest in this stock, last quarter, Gabelli Funds reported owning more than 514,000 UNS shares.
Southwest Gas Corporation (NYSE:SWX), a natural gas utility servicing some 1.9 million customers in Arizona, Nevada, and California, and operating an underground piping contractor, is also one of the least volatile stocks among the S&P SmallCap 600 stocks. SWX has a dividend yield of 2.8%, payout ratio of 46% of the current-year EPS estimate, and five-year annualized dividend growth of 9.5%. The stock recorded an annualized total return of 13.8% over the past five years. Its price has risen 12.8% over the past year. SWX has paid a dividend since 1956 and is thus attractive for income investors. Its growth record is also impressive. Last year, the company grew its EPS by 18% to a new record, while its construction services segment realized a 25% year-over-year growth in revenues, which boosted the segment's earnings to the second highest in history. The company is expected to increase its overall EPS at a CAGR of 6.0% for the next five years. In terms of valuation, the stock is trading at a below-industry forward multiple of 16.8x. Its price-to-book of 1.7 is also lower than its industry's 2.2, but it remains above the stock's five-year historical average of 1.4. Last quarter, value investor Mario Gabelli reported owning some 1.5 million shares of this company.
Northwestern Corporation (NYSE:NWE), doing business as NorthWestern Energy, provides diversified electricity and natural gas services to customers in Montana, South Dakota, and Nebraska. This stock also has one of the historically lowest volatilities of returns among small caps. It boasts a dividend yield of 3.8% on a payout ratio of 62% of the current-year EPS estimate. The company's five-year annualized dividend growth is 2.9%. NWE's annualized total return averaged 13.2% over the past five years. The stock has gained 14.2% over the past 12 months. NWE appears to be fairly priced at 16.4x forward earnings, trading on par with its respective industry. In terms of growth, the company expects to achieve diluted EPS in the range of $2.40-$2.55 in fiscal 2013, in line with analyst expectations, and slightly below its prior-year figure. Analysts forecast its long-term EPS CAGR to 5.0%. The company operates in strong economic environments, in which the unemployment rate is lower than the national average rate, while population growth is faster, on average. These factors support the company's organic growth capacity, with potential annualized organic growth of about 75 basis points. Last quarter, the stock was a popular choice of Adage Capital, which doubled its NWE position to about 1 million shares (check out the hedge fund's top holdings).
Avista Corp. (NYSE:AVA) provides electricity to 362,000 customers and natural gas to 320,000 customers in parts of Washington, Idaho, and Oregon. It also ranks one of the stocks with the lowest realized volatility among the S&P SmallCap 600 constituents. AVA has a dividend yield of 4.5%, payout ratio of 70% of the current-year EPS estimate, and five-year annualized dividend growth of 26.7%. The stock achieved an annualized total return of 9.9% over the past five years, and has gained 6.4% over the past 12 months. AVA is better priced than its peers, trading at 15.5x forward earnings. Its price-to-book of 1.3 is below its industry average of 1.8 but higher than the stock's five-year average of 1.1. The company performed poorly last year due to unseasonably warmer weather in a couple of quarters, higher expenses, and continued slow load growth. However, AVA expects a turnaround this fiscal year, with its EPS projected to rise to a $1.70-$1.90 range from $1.32 in fiscal 2012, as the company implements several base rate increases. The utility's long-term EPS CAGR target is 4%-to-5%, with low-risk rate base growth of 4%-to-5%. AVA has had 11 consecutive annual dividend increases, and targets a payout ratio range of 60%-to-70%. In terms of hedge fund interest, last quarter, billionaire Ken Fisher trimmed his position in AVA, while Clint Carlson (Carlson Capital) initiated a new position.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Dividendinvestr is a team of analysts. This article was written by Serkan Unal, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.