Now that value is back in vogue, dividends are outperforming. But now that takeovers are also back on, dividend-paying Small Caps are doing even better. Yes, returns are accelerating, but consistency is the key.

Over the past 4 years, we have generated more than 2 Small Cap Dividend Portfolios a year. How have we gone? Our average return is just under 20% versus the S&P All Ords Index return of just under 6%.

Both Dividend Portfolios we recommended in June and October 2020 have performed well, significantly outperforming a strong S&P/ASX All Ordinaries Index. The October 2020 Portfolio has returned 23.3%, representing an annualised rate of over 50%. We don’t expect this rate to be maintained but we drill down and look in detail at its constituents.

Read more about Investing in Small Caps. Why we picked these ASX Small Cap gems and their outstanding performance.

Corporate activity in Small Caps

A key takeout is the benefit of corporate activity in a Small Cap Dividend Portfolio. This is unlikely to occur at the big end of town. See our note on the takeover offer for Capral (CAA).

In the October 2020 Portfolio Capral (CAA), Gale Pacific (GAP) and SRG Global (SRG) were the best performing stocks. CAA was in both portfolios. CAA paid a 45-cent final dividend in March, GAP paid a 1-cent special dividend with its 1-cent interim dividend, and SRG reassured investors that its business is now more maintenance than construction as well as paying a 1-cent interim.

Headwinds

The October Portfolio was negatively affected by the gold price, which could easily reverse in the next few months.

Austal (ASB) was also a negative contributor, as defence stocks fell out of favour and investors focussed on the potential looming US production hiatus. Pacific Current (PAC) was down only marginally after the payment of its interim dividend and is a long-term play that should be held in limited quantities.

The benefits of fundamental analysis

The June 2020 Portfolio was put together at a highly uncertain time with regard to the payment of dividends. Many interim dividends (for the period to 31 December 2020) had been cancelled or postponed, and COVID-19 shutdowns were in full force.

We are pleased that the vast majority (13/14) of portfolio companies did pay a dividend at least in line with our forecasts at the time. The exception was Alliance Aviation (AQZ) which instead chose to raise funds for a major capacity expansion and to conserve its cash. The market loved the plans, and the stock has performed very well. AQZ has long been an Under the Radar favourite which some subscribers may still have at much lower prices.

A secret benefit of dividends

One of the secret benefits of investing for dividends on the basis of fundamentals is that more often than not it pays to average down.

When one or more of the stocks that you select falls in price, as long as the fundamentals remain intact, it is an even cheaper bargain. Subject to your risk tolerance, you could get more stock cheaper. It is much easier to hold an investment that is delivering an income, even if the capital has gone down than it is to hold a speculative investment in the hope that a greater fool will still want to buy it from you.

Diversification pays dividends

Both Portfolios were sufficiently diversified, with 11 and 14 stocks each, but not so diversified that they could not outperform. There were no complete disasters that dragged the portfolio down. It only takes one really bad performer to overwhelm some good stock picks.

If you are interested in learning more about Blue Chip Stocks and how to invest in this area, read more here.

Final tips for Small Cap dividend hunters

If you are investing primarily for income, err on the side of caution in your selections. Choose stocks with stronger balance sheets, like Austal (ASB) which although it was the worst performer in the June Portfolio, paid its dividends as forecast, is making money at over $100m a year, has well over $200m net cash on the balance sheet, and is valued at $750m.

Occasionally we have to downgrade stocks to a negative recommendation, Take Profits or Sell. If subscribers are invested primarily for income, we do strongly suggest you take some profits or cut your losses for some of your position at least. You can always go back for another look later.

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