Small Cap Dividend Growers Still Packing a Punch

NEW YORK ( TheStreet) -- I've long been a proponent of stock screening in order to not only generate specific ideas, but also to try and identify groups of stocks with particular attributes that may demonstrate the ability to outperform the market. These are not always successful over time, but it is still worth the effort because there is much to be learned.

The past few years, I've run a stock screen early each January designed to identify smaller companies that have a strong record of dividend growth, and also appear to have the wherewithal to continue raising their dividends in the future. The level of yield here is not of great concern to me, as this is not meant to be an income generation strategy.

The focus on growing dividends is due to the fact that I've long been a believer that dividends represent more than just cash that is returned to shareholders. In my view, when companies raise their dividend year in and year out, it can be a good indicator not only of financial health, but also of confident management. Furthermore, you can't fake dividends. Companies can manipulate earnings, but with dividends, what you see is what you get. There is also a built-in system of checks and balances; companies that raise their payouts to the point of unsustainability ultimately risk having to cut their dividends, which is rarely, if ever, viewed positively by the markets.

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

In January, 27 companies made the cut, and the group is up an average of 13.54% versus a gain of 12.15% for the Russell 2000 Index, and 13.47% for the S&P600 Small Cap Index since that column ran. That is certainly not great relative performance year to date, but given the history of this search it is compelling enough to continue studying it. In the past, this search has performed better on a relative basis when markets are flat or down. Two years ago (the class of January 2011), for instance, the 18 qualifiers returned an average of 13%, while the Russell 2000 was down 0.6% and the S&P 600 was up 4.3%. Hopefully we won't get to test that theory in the near future.

So far, this year, leading performers include Monro Muffler ( MNRO), up 40%, Devry ( DV) up 33%, StanCorp Financial ( SFG) up 33%, UMB Financial ( UMBF) , up 29%, and Bank of the Ozarks ( OZRK), up 29%. Just five names are in negative territory, and the worst performers are Lindsay ( LNN), down 7% and Ceramics Carbo ( CRR) down 15%.

MNRO Chart MNRO data by YCharts

Stay tuned for more on small cap dividend growers.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.