5 Small Cap, Dividend-Paying Stocks Screened For Upside Potential

by: Marc Courtenay

"If the winds of fortune are temporarily blowing against you, remember that you can harness them and make them carry you toward your definite purpose, through the use of your imagination." Napoleon Hill (Author, Think and Grow Rich, 1883-1970)

Sometimes we have to use our imagination and dig deep to find a stock that is growing its revenues, its earnings and its operating margin while keeping its debt on the manageable side.

If that company also is paying out some of its profits in the form of a dividend, then this investment may deserve our purposeful attention. The better growth companies are led by smart, enterprising management, or as one savvy CEO once told me, "The harder and smarter I work, the luckier our shareholders get".

One of the ways you can find a company/stock that fits the criteria described above is to employ the use of careful screening techniques as well as metrics that matter. That's why I especially look for companies that have "manageable debt", a market cap below $2 billion, a PEG ratio of under 2 and an operating margin above 10%. This makes for a relatively short list indeed!

To shorten the list more I want this company to pay at least a 1% dividend, have a forward PE ratio of less than 15 and have some positive free cash flow.

The following five companies are examples of what I see as a growth oriented, fairly priced, well-managed, shareholder-friendly smaller companies that have room to grow and run.

The first one was a surprise to me and by some standards controversial. World Wrestling Entertainment (NYSE:WWE) has both an operating margin above 8% and a return-on-equity (ROE) of above 8%. ROE measures a company's efficiency at generating profits from every unit of shareholders' equity (also known as net assets or assets minus liabilities).

ROE shows how well the management of a company uses investment funds to generate earnings growth. ROEs between 15% and 20% are more desirable, but not easy to find.

World Wrestling Entertainment, has a number of ways to increase and improve its ROE. As an integrated media and entertainment company, it engages in the sports entertainment business.

The company also develops content centered around its talent, and presents at its live and televised events featuring World Wrestling Entertainment. It operates through four segments: Live and Televised Entertainment, Consumer Products, Digital Media, and WWE Studios.

The Live and Televised Entertainment is where it can really grow its revenues and earnings. This segment conducts live events; produces television shows, and sells merchandise at its live events.

It also provides sponsorships, such as various promotional vehicles, including Internet and print advertising, arena signage, on-air announcements, and pay-per-view sponsorships for advertisers and offers television rights. WWE are pros at marketing and promoting the storylines associated with pay-per-view events, which are more popular than ever.

With a current 5.3% dividend yield, this is a unique investment theme with close to a 40% upside potential if it recaptures ("pins") its current 52-week high of $14.10 per share.

City Holding Company (NASDAQ:CHCO) is a $2.8 billion bank holding company headquartered in Charleston, South Carolina. On January 23,2012 they announced financial results for the year ended December 31, 2011. The Company's earnings increased $1.7 million from the year ended December 31, 2010 to $40.7 million while loans and deposits continued to grow as evidenced by a $108 million (5.8%) increase in the Company's loan portfolio from December 31, 2010 and an $87 million (7.2%) increase in its average non-time deposits from 2010 to 2011.

CHCO also reported net income per diluted share for 2011 of $2.67 compared to $2.47 per diluted share 2010. Net income for 2011 was $40.7 million compared to $39.0 million for 2010. For 2011, the Company achieved a return on assets of 1.51%, a return on tangible equity of 15.7%, a net interest margin of 3.89%, and an efficiency ratio of 55.9%.

Being a bank holding company would make its total debt higher than what I usually like, but it seems manageable when I saw that the fourth quarter of 2011 the Company reported net income of $9.7 million, or $0.65 per diluted share compared to $9.9 million, or $0.64 per diluted share for the fourth quarter of 2010. In other words, during a tough economic climate they're still making money.

CHCO pays a respectable and sustainable 4% dividend. To learn more about them and to see for yourself why their potential is encouraging look at their web site by clicking here.

One way to play the rebound in commercial real estate and consumer spending is to consider a REIT called One Liberty Properties, (NYSE:OLP) a Great Neck, N.Y. REIT with a property portfolio which includes retail furniture stores, as well as industrial, office, flex, health, fitness, and natural food-related properties.

What really caught my eye about this company is that some of the major holders are insiders. This includes the Gould family (Jeffrey Gould is Senior V.P and a Director), who together, along with Gould Investors LP (a powerhouse in the REIT business as their web site makes abundantly clear) own over 2 million shares of OLP.

They generate hearty "funds-from-operation" through investing in real estate that is leased to companies like Whole Food Markets (WFM) and a number of profitable fitness centers. They're doing well enough to have raised their dividends for the past two years to its current 7.2% level.

At the end of 2011 OLP was named the top dividend-paying stock with insider buying by Forbes.

The fourth smaller cap stock that meets most of the above criteria is Alliance Financial Corp. (NASDAQ:ALNC). They're a bank holding company for Alliance Bank, N.A., which provides various financial products and services to commercial, retail, government, and investment management customers in New York.

They have a profit margin of better than 21% and their operating margin is a strong 32% plus. Their 10% ROE (TTM) and their 4.2% dividend yield bodes well for patient growth investors who want income as well.

The PEG ratio for ALNC is a little high at around 1.9, but in the current interest rate environment and the Fed's relatively loose monetary policies, ALNC should be able to grow their earnings between 7 to 10% per year over the next 5 years. They will also likely grow via acquisitions and mergers.

In spite of Fed Chairman's Bernanke "slightly more hawkish" comments which disappointed investors on Wednesday, the Federal Reserve will be doing all they can to help banks grow stronger in the months ahead, including the promotion of more generous lending practices.

The fifth company speaks to the growing need for healthcare for America's aging population. There are still over 100 million "baby boomers" and their parents alive today whose need for nursing and medical care are swelling with each passing day.

National HealthCare Corporation (NYSEMKT:NHC) is a growing company that targets this specific gargantuan need. It operates and manages long-term health care, retirement, and associated assisted living centers, as well as provides home health care and hospice services in the United States.

NHC provides subacute skilled and intermediate nursing and rehabilitative care services; inpatient and outpatient rehabilitation services; senior living services; home health care services; management services; hospice services; and management, accounting, financial, and insurance services to third party owners of health care facilities.

Their Yahoo Finance Key Financial Statistics page looks like the kind of company that I'm screening for on a regular basis. This includes their modest debt versus their total cash (most-recent-quarter). Their ROE of 11% is encouraging and their current and forward PE (12 and 16, slightly above my 15 comfort level) indicates good value and the promise for growth.

Yes, their quarterly earnings and quarterly revenue growth (year-over-year) leaves room for improvement. The great news here is that the owners, insiders and director are major holders of the stock. 31% of the outstanding shares are owned by insiders and "5% owners".

There are approximately 13,842,117 outstanding shares, currently trading around $45.70 per share. The average daily volume is only 30,000 shares, so it tends to be volatile as the 1-year chart shows.

NHC pays a 2.6% dividend that is backed by a trailing-twelve-month operating cash flow of $81 million and levered free cash flow of $41 million. Obviously the insiders and directors feel very comfortable owning the stock.

I personally want to wait till the stock challenges it 200-day moving average price of around $41.65 before taking more than a token position.

Don't wait too long to check out these 5 remarkable companies and consider accumulating shares when share prices seem like a "bargain" to you. It's your money, so take your time and be picky!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.