A Small-Cap Dividend Strategy

08/09/2013 9:00 am EST


Tyler Laundon

Editor, Cabot Small-Cap Confidential

When these growth companies are also dividend growers, the potential for outperformance is off the charts; as such, I'm intrigued by this new, specialty ETF, says Tyler Laundon in Daily Profit.

In fact, 30 years of data show that dividend-growth stocks trounce other stocks. By far, small-cap dividend growth stocks are the best performers.

According to Ned Davis Research, the average annual returns for small-cap dividend growth stocks are around 20%. You can't beat that performance with large or mid-caps. As an added bonus, Ned Davis Research also shows that dividend growth stocks tend to be less volatile than their counterparts.

The WisdomTree Small-Cap Dividend Growth ETF (DGRS) is part of a slew of new specialty ETFs.

This brand new fund takes WisdomTree's own Dividend Growth ETF (DGRW) and makes it better by cutting out the largest 300 companies, then taking only the smallest 25% of the companies that are left.

The result is a fund of 169 companies that resembles a dividend growth strategy on caffeine, and which capitalizes on three of the best performing stock attributes over the long-term; small companies, earnings growth, and dividend growth.

Around 50% of the fund's portfolio is allocated evenly to consumer discretionary and industrial stocks, while another 25% is split between technology and materials stocks.

Delving in to the fund's top ten holdings you'll see that Questcor Pharmaceuticals (QCOR) is the largest holding, with a weight of 3.6%, and which pays a dividend yield of 2.0%.

Questcor only recently initiated its dividend, and has paid just four dividends in its short history. But clearly the fund manager sees potential here, supported by a recent 25% hike in the dividend.

Publishing company Meredith Corporation (MDP), which yields 3.4%, is also among the top ten holdings. This company has a long history of dividend growth dating back to the mid-1990s and is a perfect fit for the DGRS.

And The GEO Group (GEO) is yet another compelling holding that most investors haven't heard of. The company operates correctional and detention facilities for various governments.

I might not like the fact that for-profit prisons exist, but growth and stability in the sector is too hard for income investors to ignore. The specialty-REIT offers a 5.6% yield, and the dividend more than doubled in 2013 to $0.50 a quarter.

No one stock is going to make or break this fund's performance. So investors need to be on board with the broader strategy of small-cap dividend growth, and to some degree, not worry about the movements of any particular holding.

The attraction of an ETF like the DGRS is the one-stop-shopping efficiency that the fund's strategy offers to investors. Concerning oneself with any single stock, in many ways, defeats the purpose.

This is an entirely new fund, so don't jump in with both feet. At the latest reading, DGRS has a net asset value of $2.5 million. Given the infancy for the fund and the unique strategy, I would expect that to grow in 2013.

I recommend dollar cost average into the ETF to gradually achieve your desired position size. This will make you far more comfortable investing in this brand new fund than an all-in, all-at-once strategy.

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