Boost Your Dividend Growth Portfolio With These 3 Small-Cap Dividend Contenders

Includes: AVA, FKYS, NKSH
by: On Base

Three Dividend Growth Contenders

In this article I identify three small-cap Dividend Contenders for possible inclusion in a dividend growth portfolio. Based on financial strength, safety (stability), value, dividend, and dividend growth, I selected the three companies from the 54 small-cap Dividend Contenders in the November 29, 2013, CCC List (CCC List). The Contenders are companies that have paid a growing dividend for 10 years or more but have not achieved the Dividend Champion's 25+ years of dividend growth. Here I use the definition that small-cap companies have a market capitalization between $100 million and $2.3 billion.

My Small-Cap Dividend Growth History

The dividend growth portfolio that I developed in the last 19 months has holdings in 5 small-cap companies [National Bankshares (NASDAQ:NKSH), RF Industries (NASDAQ:RFIL), Triangle Capital (NYSE:TCAP), Teche Holding (NYSEMKT:TSH), and Valassis Communications (NYSE:VCI)]. These small caps comprise 7.2 % of my portfolio, an amount that exceeds the 1.2 % market cap of the small-cap companies on the Dividend Contenders list. I justify my factor of 6 overweight because I feel that quality and fairly-priced small-cap stocks, over the long term, will produce stronger returns than large-cap companies.

Using the performance of the exchange-traded funds SPY (as a proxy for the S & P 500), IJS (a proxy for the S & P Small-Cap 600), and IWM (a proxy for the Russell 2000), I measured an increase of 2 to 9 percent of the small-cap indexes over the S&P 500 in the last 2 years. This margin will change with time, but has driven my overweight in small-cap companies.

This Analysis

The goal of this analysis is to identify quality companies with high current yield and high growth of yield. I determined quality by examining the financial strength, and safety (stability) of each small-cap Dividend Contender. I also examined the value, based on the price of the stock relative to its earnings, of each small-cap Dividend Contender. I narrowed my list to three small-cap Dividend Contenders after examining the current yield and growth of yield of the identified quality companies.

Consistent with my previous work (Small-Cap Champions), I first identified the financial strength and safety from ratings and data that are published by ValueLine, S & P Netadvantage, and, Morningstar (Morningstar). I accessed these ratings and data through my public library.

ValueLine (VL) covers 14 of the 54 small-cap contenders (26 percent). I qualified seven of the companies to be worthy of further investigation based on financial strength (B+ or better) and safety (a rating of 1 or 2 out of 1 to 5). I show these small-cap Dividend Contenders on the following table.

Small Cap Dividend Contenders that are Qualified on Financial Strength and Safety

VL Rating
Company Name Stock Symbol Financial Strength Safety (Stability)
Avista Corp. AVA A 2
Healthcare Services Group Inc. HCSG A 2
J&J Snack Foods Corp. JJSF A 2
Laclede Group Inc. LG B++ 2
New Jersey Resources NJR A 1
South Jersey Industries SJI B++ 2
York Water Company YORW B+ 2

To address the 40 small-cap Dividend Contenders that are not rated by VL, I considered financial data provided by S&P Netadvantage and Morningstar. I rated a company to have satisfactory financial strength if it consistently increased revenue and earnings per share from 2007 to the present. I evaluated the safety (stability) of these 40 small-cap stocks based on their beta coefficients. (To qualify, the company has to have a one-year annualized beta coefficient of less than 1.0). I show the additional six small-cap Dividend Contenders, qualified on financial strength and safety, in the following table.

Six Small-Cap Dividend Contenders with Strength and Safety

Company Name Stock Symbol Financial Strength Safety, Beta Coefficient
Community Bank System CBU Strong 0.68
Citizens Financial Services OTCPK:CZFS Strong -0.18
First Keystone Corp. OTCPK:FKYS Strong 0.17
Hingham Institution for Savings HIFS Strong 0.63
Mesa Laboratories Inc. MLAB Strong 0.72
National Bankshares, Inc. NKSH Strong 0.57

Of the 13 small-cap Dividend Contenders qualified on financial strength and stability, four are regional banks [((NYSE:CBU)), ((OTCPK:CZFS)), ((OTCPK:FKYS)), (NKSH)] five are utilities [((NYSE:AVA)), (LG), ((NYSE:NJR)), ((NYSE:SJI)), ((NASDAQ:YORW))], one processes and packages food ((NASDAQ:JJSF)), one provides medical instruments and supplies ((NASDAQ:MLAB)), one provides business services ((NASDAQ:HCSG)), and one is a savings and loan ((NASDAQ:HIFS)).

Finally, I looked at the valuation (that is, the fraction of the company, and hence earnings, we buy with each share price), and yield (dividend) and promised yield (dividend growth) of the financially strong and stable Dividend Contenders. Before going further, I will explain my findings regarding the recent distortion of dividend payments.

Accommodating the Recent Distortion of Dividend Payments

David Fish lists 48 dividend growth companies (Phantom Cuts) that moved at least one dividend payment from 2013 into 2012. The effect is that the companies will pay a smaller dividend in 2013, leading to the appearance that the companies have reduced their dividend. Of the small-cap Dividend Contenders that I am examining here, David Fish cautions that the four companies, Atrion (NASDAQ:ATRI), First of Long Island (NASDAQ:FLIC), J&J Snack Foods (JJSF), and Oil-Dri of America (NYSE:ODC) have accelerated their dividend payments. From my examination, I agree that ATRI and ODC have accelerated dividend payments. On the other hand, I believe that JJSF and FLIC observe unusual dividend payment schedules that were mistaken for accelerated dividend payments. JJSF raises its dividend in the last payment of the year, thus, presenting the image of an accelerated dividend in year 2012. FLIC makes dividend payments in March, July, October and December; this schedule misses a payment in the first quarter and makes two payments in the fourth quarter. The payout looks like an accelerated dividend payment, but it is not, in my estimation. I found that Citizens Financial Services made an accelerated dividend payment in 2012, and should be added to David Fish's list of companies with phantom dividend cuts.

My Final Selection

In the following table, I offer three Dividend Contenders for consideration as a small-cap component to your dividend growth portfolio.

Three Recommended Small-Cap Dividend Contenders for a Dividend Growth Portfolio

Company Name Stock Symbol Market Cap, million $ Years of Increasing Dividend Annual Yield Dividend Growth, 5-yr ave
Avista Corporation AVA 1,630 11 4.48 % 11.12 %
First Keystone Corp. FKYS 142 12 4.09 % 3.40 %
National Bankshares NKSH 263 14 2.95 % 7.18 %

Avista Corporation generates and distributes electricity from hydroelectric, thermal resources, and wind; and engages in the wholesale purchase and sale of electricity and natural gas in the western United States and Canada. It offers invoice processing, auditing, payment services, and energy procurement services. In addition, the company custom fabricates sheet metal for electronic enclosures, parts, and systems for computer, telecom, renewable energy, and medical facilities. Avista invests in real estate, primarily in commercial office buildings, and invests in emerging technology venture capital funds and a fuel cell business. Avista Corporation was founded in 1889 and is headquartered in Spokane, Washington.

First Keystone Corporation provides banking and related financial services to individual, business, government, and public and institutional customers in northeastern Pennsylvania. The company provides personal and corporate trust and agency services that include trust investment accounts, investment advisory services, mutual funds, estate planning, management of pension, and profit sharing plans to individuals and corporations. It operates 16 branch locations. First Keystone Corporation was founded in 1864 and is headquartered in Berwick, Pennsylvania.

National Bankshares Inc. provides a range of retail and commercial banking services to individuals, businesses, non-profits, and local governments. The company operates 25 offices in Southwest Virginia. In addition, the company, through its subsidiary offers non-deposit investment and insurance products. National Bankshares, Inc. was founded in 1891 and is headquartered in Blacksburg, Virginia.

The Other Ten Dividend Contenders with Strong Finances and Safety

Of the small-cap Dividend Contenders with strong finances and safety (stability), I judged seven to be overvalued (CBU, HCSG, JJSF, MLAB, NJR, SJI, YORW) based on their share price and earnings. I did not recommend the Hingham Institution with a dividend yield below 2 percent, or Citizens Financial Services with a dividend of 2.40 percent, or the Laclede Group with the low five-year average dividend growth rate of 2.71 percent.

Final Word

Avista Corporation is a financially strong diversified utility with an annual yield and the dividend growth (seen as percentages in the previous table) that presents an attractive entry point. The two regional banks, First Keystone and National Bankshares exhibit financial strength and safety (stability), have raised their dividends 12 or more continuous years, and are fairly valued. As always, I recommend that the reader conduct further due diligence before making any investment decisions..

Disclaimer I provided analysis in this document for informational and educational purposes. My recommendations are a starting point for stock selection and should not be construed as a definitive position to buy or sell the stocks mentioned. The information in this document is believed to be accurate, but you should independently verify the status of a company before making a buy or sell decision. I am a scientist, by profession, and have no formal training as an investment adviser.

Disclosure: I am long NKSH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.