Investors are facing several macro issues in the current environment. Inflation remains stubbornly high, tight energy supply and demand conditions have made energy very expensive, the war between Russia and Ukraine is still going on, and the increase in interest rates is poised to hurt economic development eventually.
In an environment like this, many investors are flocking towards safe high-yielding income stocks, which makes sense, as these can offer inflation protection on top of the income they offer. The instinct of many investors is to go with the largest companies as these are often seen as the safest choices, but that does not necessarily hold true.
Small-cap stocks can offer safety and solid income yields as well, and when they aren’t as popular, they can trade with lower valuations, providing for more attractive entry points.
Here, we will thus discuss three small-cap income stocks investors should take a look at.
Time to Clean Up With This Dividend Payer
The first such small-cap income stock is Tennant Co. (TNC) , a manufacturer and seller of cleaning products, such as floor cleaning machines, and cleaning solutions. The company primarily sells its products and services in the United States and China, but it is active in more than 100 additional countries on top of that.
In the fragmented market it operates in, Tennant is the market leader, which provides competitive advantages via stronger scale that allows for more efficient operations. Tennant has historically pursued M&A actively, seeking to acquire smaller peers to grow its business. That should continue, providing growth tailwinds, while market growth, especially in China, is also an important growth driver going forward.
Tennant is currently valued at $1.1 billion, based on a share price around $60 and a share count of 19 million. Tennant has an excellent dividend growth track record, despite its small size and the fact that its business model does not sound overly defensive. The company has proven to be quite resilient versus economic downturns, however, which is why it has been able to grow its dividend for 50 years in a row, making it a Dividend King — one of the smallest by market capitalization.
Over the last five years, Tennant has increased its dividend by 4% a year on average, which isn’t outstanding, but solid. At current prices, the company’s dividend yield stands at 1.8%, which is more than what one can get from the broader market and compares favorably to the dividend yield Tennant has traded at over the last decade, as its average yield was around 1.5% in that time frame, meaning investors currently get around 20% more income compared to the historical norm when they buy into Tennant.
At current prices, Tennant is trading for 15x forward net profits, based on the analyst consensus estimate for this year’s earnings per share, which currently stands at $3.85. That is a below-average valuation, as Tennant used to trade at a high-teens to low-20s price-earnings multiple most of the time over the last decade. From a valuation perspective, Tennant thus looks more attractive than it usually does.
Making Bank in an Enterprising Way
Enterprise Bancorp (EBTC) is a small-cap bank holding company that owns Enterprise Bank and Trust Company, usually called Enterprise Bank. Enterprise Bank operates with around 30 branches in Northern Massachusetts and Southern New Hampshire. Its offerings include commercial, residential, and consumer loans, insurance services, cash management, wealth management, and so on. The company is heavily active in commercial real-estate lending, which makes up around half of its loan book.
The company has proven to be very resilient in the past, as EPS actually increased during the Great Recession, when many other banks saw their profits evaporate. Enterprise Bank also scores well when it comes to employee happiness, which can be seen as a minor competitive advantage due to the bank getting access to new employees more easily and having better retention rates than some peers.
Enterprise Bancorp has managed to grow its dividend for 28 years in a row, giving it Dividend Aristocrat status. The dividend growth rate over the last decade averaged 6.5%, which is very solid. The dividend yield stands at 2.7% today, which is above the ~2% average EBTC has historically traded with, and also well above what one can get from the broader market. Due to EBTC’s strong dividend track record and its dividend payout ratio of just 24%, we believe that the dividend cut risk is very low.
EBTC trades at just 9x forward net profits, which is very inexpensive in absolute terms, and which represents a discount relative to how the company was valued in the past, suggesting that right now could be an opportune time to enter or expand a position.
A REIT to Feel Good About
Universal Health Realty Income Trust (UHT) is a real estate investment trust (REIT) that primarily invests in healthcare properties such as acute care hospitals, medical office buildings, rehabilitation hospitals, etc. The trust is currently trading with a market capitalization of $700 million.
Due to its small size, Universal Health does not have any scale advantages versus larger peers, but the industry is resilient versus economic downturns, which is why UHT has done well during past recessions, which should also hold true for future economic downturns.
Universal Health has increased its dividend for 36 years in a row, which is very convincing. In combination with a payout ratio that does not seem overly high, at 77% of its funds from operations, this makes us believe that the dividend is sustainable. At current prices, UHT’s dividend offers a yield of 5.9%, which is pretty attractive. That being said, it should be noted that the company has increased its dividend by just 1% to 2% a year over the last decade, thus investors shouldn’t expect a lot of dividend growth going forward.
At current prices, Universal Health Realty is valued at 13x this year’s expected funds from operations (FFO). That compares favorably to the high-teens FFO multiple UHT has traded at over most of the last decade, thus the shares can currently be acquired at a discount compared to how the REIT was valued in the past, potentially providing an attractive entry point. At the same time, multiple normalization could be a tailwind for future total returns.
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