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Locating Small-Cap Dividend Dependability

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Large-cap dividend cutters are getting plenty of attention, but their small-cap peers aren’t angels, either. Across the S&P MidCap 400 and S&P SmallCap 600 indexes, there have been more than 110 instances of negative dividend action this year.

All that negative dividend news with small companies highlights the importance of steady strategies, such as the ProShares Russell 2000 Dividend Growers ETF (SMDV). SMDV, a dividend spin on the Russell 2000, the benchmark U.S. small-cap index, tracks the Russell 2000 Dividend Growth Index, which includes small-cap firms with dividend increase streaks of at least a decade.

“However, smaller stocks have taken a much bigger hit than their large-cap brethren, and the payout pain probably isn’t over yet—especially if the pandemic’s economic fallout lingers,” reports Lawrence Strauss for Barron’s.

When Cash Matters

A primary reason why small-cap companies can be big-time dividend offenders is that they often lack adequate cash to maintain payouts when times are tough. However, SMDV’s dividend increase streak requirement is a sign that many of its components are well-capitalized.

SMDV’s dividend dependability is all the more important at a time when small-cap stocks are joining their large-cap peers in being dividend offenders. Along with the focus on smaller companies, investors should also look to dividend growers to potentially enhance long-term returns.

SMDV’s 10-year dividend increase streak mandate can also be a sign, in some cases, that member firms aren’t carrying heavy debt loads. Leverage remains a key challenge for these smaller companies, but if we focus on small- and mid-caps with less leverage, like those that have consistently grown dividends, investors may find opportunities. Many of SMDV’s components carry stronger balance sheets than small-cap companies that aren’t dividend payers.

Smaller companies “on average carry a lot more debt than larger companies do and generate much less free cash flow as a percentage of sales,” according to Barron’s.

Many small-cap dividend offenders hail from energy, real estate, and consumer discretionary. However, SMDV has no energy exposure and the other two sectors combine for just 8% of the fund’s roster.

For more on core investing strategies, please visit our Core Equity Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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