6 Small Stocks Paying Big Dividends

Angling for yield? it might be time to troll for the stock market's most attractive minnows: small companies that pay big dividends.

To be sure, it's easier to find big yields from giants such as AT&T and Altria. But some experts believe that income investors have overfished the big-company waters, pushing the prices of some high-yielding behemoths beyond the edge of fair value. Small companies, however, are often overlooked. They can be too tiny to lure the whale-sized institutions that dominate Wall Street. And that can spell opportunity for individual investors, who aren't buying shares in multimillion-dollar blocks. "A lot of larger firms just don't look at companies that are under a certain size," says Adam Menzel, chief operating officer of BNK Invest, which runs DividendChannel.com. "These are companies with solid fundamentals, but they get left off a lot of articles and research reports."

Of course, no matter how high a stock's yield, investors still have to ask two overriding questions: What are the stock's prospects? And is the rich dividend sustainable? There's no better way to lose money than to buy a stock right before the payout is cut.

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That said, a number of small companies pay gen­erous dividends and have bright prospects for share-price appreciation. Here are a half-dozen minnows that pay delectable dividends.

Testing 1, 2, 3. Working with makers of everything from windmills to snowmobiles, MTS Systems (symbol MTSC) helps its customers test prototypes of new products for reliability, stability and durability. The 47-year-old Eden Prairie, Minn., engineering company generates only about one-third of its revenues in the U.S.; nearly 40% of its sales come from fast-growing manu­facturing centers in Asia. Although the global economy is improving, growth is likely to remain restrained for some time. That's good news for MTS, says Sidoti & Co. analyst John Franzreb. When competition is fierce, businesses feel pressured to develop more new products. To get these products to market quickly, they rely on the testing expertise of companies such as MTS.

MTS has a strong balance sheet, with virtually no outstanding debt and cash reserves of nearly $80 million, or 10% of the stock's market value. At $57, the stock yields just 2.1%, but the current annual dividend rate of $1.20 per share has tripled since 2006.

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Insiders own about 30% of the shares of Electro Rent (ELRC). That can be a problem when insiders care mostly about enriching themselves at the expense of other shareholders, but in this case it's a plus, says Sidoti analyst David Gold. "They manage the company tightly, like it's a family business," he says. "They're watching every penny." As a result, Electro Rent, which buys and leases out high-cost technology and testing gear for the aerospace, defense and telecommunications industries, has no debt and an unused $25 million credit line. This enviable balance sheet enabled Electro Rent to acquire its third-largest rival during the 2007–09 recession, and it puts the Van Nuys, Cal., firm in a position to grow far more briskly in the future, says Gold.

Although Gold doesn't expect profits to rise in the current fiscal year, which ends in May, he projects that both sales and earnings will grow by double-digit percentages in 2014 and beyond. At a price of $15, Electro Rent shares yield 5.2%.

First PacTrust Bancorp (BANC) has transformed itself over the past five years, says D.A. Davidson & Co. analyst Gary Tenner. The parent of Pacific Trust Bank started as a credit union, then converted to a savings and loan, and now has turned itself into a commercial bank. The credit union and S&L businesses borrowed money by offering relatively high-yielding certificates of deposit and lent out money at relatively low rates. That kept the company's profit margins slim.

Now the Irvine, Cal.–based bank is going after potentially more-lucrative commercial loans and shifting its deposit base into short-term checking accounts, which pay low or no interest. First PacTrust is also on an acquisition spree that could double its size in the next two years, says Tenner. Meanwhile, analysts expect earnings to grow at an average of about 15% annually over the next few years. The stock, at $12, yields 4.1%.

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Like Electro Rent, G&K Services (GK) is in the rental business. But instead of leasing high-tech gear, G&K leases (and launders) uniforms for hotels, grocery stores, fast-food outfits, manufacturers, health care concerns and construction firms. It's not a sexy business, but it has proved resilient even in tough economic times, says Kevin Steinke, of Barrington Research. And now that the economy is picking up a little steam, there's a good chance that the Minnetonka, Minn., company could, too.

G&K executives, who paid off debt and conserved cash through the recession, are now so confident about the company's prospects, says Jeff Huebschen, director of investor relations, that they hiked the dividend rate by 50% last June. At $40, the stock yields just 2%. But if history is any guide, the payouts will keep rising. G&K's dividend has increased fivefold in the past six years. Steinke thinks the stock will appreciate in line with the company's improved prospects.

Publisher on sale. Rumor has it that publishing is dead, but don't tell John Wiley & Sons (JW-A). The Hoboken, N.J., publisher concentrates on scientific and financial books and journals that have become "must reads" for many academics and experts in these fields, says Morningstar analyst Michael Corty. Wiley reported weak earnings for the May–October period (the first half of its current fiscal year) and announced that sales would be down for the full year. But that's due to a restructuring plan that involves the sale of lagging consumer publications and the expansion of Wiley's efforts in online learning and technical books and journals, where the prospects are brighter.

Because of disappointing results recently and concerns about the outcome of the restructuring campaign, the stock, which traded for $51 last September, now goes for $38. At that price, it yields 2.5%. Wiley has raised its dividend for 19 straight years, most recently last June, when it hiked the quarterly payout by 20%, to 24 cents per share.

If you run a small techno­logy firm and need to borrow some scratch — maybe $25 million or so — you might turn to TICC Capital (TICC), a business-development company based in Greenwich, Conn. And if you happen to be an investor looking for some serious income, you might turn to TICC's stock, which at a price of $11 yields a stunning 10.9%. Run by a group of former investment bankers and small-company-stock in­vestors, including Charles Royce, founder of the Royce funds, TICC borrows money by issuing debt and then seeks to profit by lending the money at higher interest rates to middle-tier technology com­panies or by taking equity positions in them.

This is a risky business, however, and TICC, not surprisingly, is the riskiest stock on our list. For starters, because the companies TICC invests in are young and small, they stand a much greater chance of failing than, say, IBM. Moreover, because TICC invests with borrowed money, it is at the mercy of the credit markets, which, as we saw only a few years ago, can freeze up during a financial crisis. During the last recession, TICC slashed its dividend by 44%, and its stock price, which had exceeded $17 in 2007, fell below $3 in early 2009. The company has been hiking dividends steadily since the recession ended, from 15 cents per quarter in early 2010 to a current rate of 29 cents.

With the economy expanding slowly, the risks of another credit crisis and a rise in defaults are declining. John Hecht, an analyst with Stephens Inc., thinks TICC's dividend is safe and that as the company deploys more of the capital it borrowed last year, profits will rise and lead to even richer payouts for shareholders.