It's no secret, safe yield is hard to find these days in the capital markets. The kid's movie "Finding Dori" just hit the theaters this summer, but the adult saga in the financial markets is more like "Finding Yield," because there's not much to be found in the markets today.
The corporate bond market has been unstable at best lately and don't even think about trying to buy sovereigns, the U.S. 10-year yield is flirting with all-time record lows again as Central Bankers around the world appear determined to support markets and pump up bond prices.
So, the natural thing to do is look to blue-chip stocks for yield, which offers some interesting opportunities. But for the most part, many of the big names are getting bid up, driving their yields down to levels that make them not much more attractive than c-bonds, with more potential risk.
Where does that leave you as an income investor?
Well my friend, it's time to start looking at the lesser known companies in the public markets. Companies that operate actual businesses with real profits run by conservative management teams that pay solid dividends, but happened to be smaller in size.
We're talking about small-cap stocks.
After scouring the markets, we found numerous firms that met our criteria, but one stood out to us in particular that you should consider giving a look. The interesting part is that it operates in the very same challenging arena as we just described: the financial markets.
Westwood Holdings Group (NYSE: WHG) is a money management firm based in Dallas, Texas that has been successfully handling the investment accounts of institutional investors, high-net worth individuals and non-U.S. clients (including sovereign wealth funds) since 1983.
The holding company's subsidiaries offer a very hands-on investment approach and provide its client base with personalized services and even an array of mutual fund options for individual investors.
What attracted us to WHG is their prudent management team, conservative balance sheet, and of course, its hefty 4.2% dividend yield. A dividend which has increased in each of the past 5 years, growing by 13.6% annualized since 2012.
Now that we have your attention, let's take a closer look at Westwood's operations, future outlook and some potential risks going forward.
Looking at the numbers, Westwood caught our attention not only because of the attractive dividend yield, but for its pristine balance sheet, growing cash flows and solid valuation metrics (below figures based on -ttm financials unless otherwise noted).
Balance Sheet - the first thing that jumps out about Westwood is that it has zero long-term debt. This is quite impressive for a financial services firm. Also, management makes it very clear in their corporate info packets that they do not use any leverage. This offers investors a level of safety that cannot be overstated in today's world of debt.
In fact, many large U.S. corporations have been ridiculed recently for borrowing enormous sums of money just to pay (or keep paying) dividends, buy back shares, or worse yet, just borrowing for the sake of borrowing because "money is cheap." With Westwood, you won't get any of those financial engineering shenanigans, just a well-run company. Also, with a current ratio of 3.03, Westwood can easily pay its current obligations with current assets on-hand.
Revenue and Cash Flow - the friend of every income investor should be growing revenues and growing/steady free cash flows. WHG offers both of these, with top-line revenue growth in each of the past 5 years and tons of free cash flow. Meanwhile, it boasts operating margins of 30%, net margins of nearly 20% and return on equity of over 21%.
Valuation - Westwood also meets many of our favorite valuations metrics, boasting an Enterprise Value to EBITDA ratio of just 8.09 and a P/E of 17.1, which is lower than the industry average of 19.2 and the S&P 500 average of 19.3. Not only that, it displays a Price-to-Cash-Flow ratio of 7.3, which is 330 basis points lower than the average of its peers, making it an attractive selection on value-basis as this is the lowest P/CF figure over the last 10 years.
Dividend Yield: 4.2%
Debt/Equity: N/A (zero long-term debt)
Current Ratio: 3.03
Operating Margin: 30.29%
Net Profit Margin: 19.18%
Return on Equity: 21.03%
Looking into the future, Westwood is projected to continue its strong dividend performance, showing a 4.37% forward annual dividend rate. Provided the markets continue to be as volatile as they have been in the first half of 2016 and more investors with large portfolios seek the advice of trustworthy and experienced money management firms, Westwood is well-positioned to prosper.
Westwood makes its bread and butter profits providing excellent service to its clients while not taking on any leverage internally. This strong financial position and focused business execution should allow it to continue generating revenue from sales and advisory services going forward.
Based on this trend, we expect Westwood to see its revenue grow again in 2017, as it continues to gain market share and bring on more clients. Despite the firm being much smaller than its more broadly known competitors, it has the most potential for higher rates of growth than many of its peers, allowing investors to realize sizeable capital appreciation over the medium to long term. This potential, along with reasonable valuations metrics, is why we like the stock so much.
Changing gears and examining the potential headwinds facing Westwood, there are a few concerns we have regarding the company and the industry, but nothing that materially changes our investment thesis.
The money management industry is highly competitive. This fact alone adds a level of risk, but Westwood has been operating successfully for over 30 years, so they have a proven track record. Also, access to quality information becomes highly sought after in times of high volatility and uncertainty (think Brexit).
This means the competition will be looking to lock-in their top clients and a battle of dog and pony shows for new clients will certainly ensue. Westwood will need to make sure it is focusing efforts on client acquisition and retention to keep its footing in the market.
The sheer size and relative amount of marketing resources Westwood has in comparison to its larger competition might make it difficult to land new business. However, its best bet is to continue its hands-on, high-service approach. This just might win them new business from clients tired of not receiving enough personal attention.
On the financial side, given its line of business, WHG is highly correlated to the overall stock market, having a Beta of 1.63. This makes it susceptible to general market downturns and should be analyzed in relation to your overall portfolio and not in a vacuum.
Lastly, Westwood's trailing twelve-month dividend payout ratio of 70.1% seems elevated and may raise an eyebrow. However, its average payout ratio over the last 10-years is 72.9%. So, it seems to be in-line with historical levels. Given that the company has zero long-term debt and minimal capital expenditure requirements, this is not enough of a concern on its own to shy away from owning shares.
Quality, safe yield is hard to come by these days. The familiar large-cap stocks are seeing their yield erode as investors bid up their shares and the companies fight to grow. Meanwhile, Westwood continues growing revenue, serving clients well and paying a fat, steadily rising dividend year after year.
Westwood might not be some flashy, high-flying growth stock or a household name with a $10 billion market cap. But sometimes there's a lot of comfort in small, steady and boring. When that comes in the form of a 4.2% dividend yield that continues to rise each year while running a financially sound business (with no debt) investors should take notice.
As usual, we suggest you practice safe wealth management by putting no more than 5% of your portfolio into this position and employ a percentage-based trailing stop loss structure that matches your tolerance for risk.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.