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TheStreet Open House

Small-Cap Dividend Growers Outperform Again

Stocks in this article: AEL SFG OZRK MW NATL LNN BMI NHC SCL

NEW YORK ( TheStreet) -- I've opined several times in this column on the subject of dividend growth, and my belief that growing dividends can be an excellent indication of a company's health. While earnings can be manipulated, when it comes to dividends, what you see is what you get; dividends can't be faked. Companies attempting to artificially prop up their dividends in order to appear healthier than they are in reality can't do so for very long. Ultimately unsustainable dividends will be cut or eliminated, and the resulting punishment from the market can be severe.

For the past several years, early in the year I've run a stock screen that was built in order to identify smaller companies with strong records of dividend growth, as well as the wherewithal to continue raising their dividends in subsequent years. This is not an income strategy; in fact dividend yield is simply not a factor.

The search criteria that I employ for this strategy includes the following parameters:

  • Market caps between $500 million and $2 billion

  • Dividend increases in at least each of the past five years

  • Long term debt to equity ratios below 50%

  • Dividend payout ratios below 50% for the trailing 12 months, and last two fiscal years

Last year, 27 companies made the list, and the average return from the performance period (Jan. 16, 2013 through Jan. 2) was 36.9%, versus 33.4% for the S&P 600 Small Cap Index, and 30.4% for Russell 2000. While that is certainly not "lights-out" performance relative to the indices, it is the third consecutive year that this strategy has outperformed. The true test, in my view, will be in years when the broad markets are in flat to negative territory. That's what happened in 2011, when the 18 companies meeting the criteria were up 13% while the S&P 600 was up 4.3%, and the Russell 2000 was down 0.6%.

The best performers last year were life insurer American Equity Life ( (AEL - Get Report), +93.6%), insurance and financial services company StanCorp Financial Group ( (SFG - Get Report), +75%), Bank of the Ozarks ( (OZRK), +65.3%), and clothing retailer Men's Wearhouse ( (MW), +61%). Overall, 25 of the 27 qualifiers were in positive territory.

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