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Funds go smaller-game hunting for dividends

| Sunday, Aug. 10, 2014, 10:40 p.m.

NEW YORK — In the hunt for dividends, biggest does not always mean best.

Big, blue-chip stocks are often the first stop for many dividend investors. Companies like Exxon Mobil or Procter & Gamble have long histories of paying dividends and higher yields than the market's average. But smaller companies pay dividends, too, and some mutual-fund managers count them among the best opportunities to find dividend growth.

That's why Don Taylor, who has managed the Franklin Rising Dividends fund since 1996, prefers companies a tier or two below the dividend behemoths. He considers the sweet spot to be companies valued between $20 billion and $50 billion. Exxon Mobil, in comparison, is worth $422 billion, and Procter & Gamble, more than $219 billion. The average market value of companies in the Standard & Poor's 500 index is $36 billion.

One of the biggest investments in Taylor's fund is Roper Industries, an industrial company worth $14 billion. At first glance, it may not look like a great dividend stock with a yield of 0.6 percent. Taylor has been comfortable with the low yield because Roper has been using a lot of its cash to buy competitors to accelerate its growth. Those acquisitions helped Roper's annual revenue quintuple over a decade.

But finding acquisitions big enough to make a significant impact on its results — at attractive prices — is getting tougher. So Taylor expects Roper to steer more of its cash toward its dividend. This year Roper hiked its payout by 21 percent.

“These companies are big enough that they're important or leading businesses, but they're not so big that it becomes really difficult to grow,” he said.

Some dividend-focused mutual funds focus on smaller companies. The Principal Small-MidCap Dividend Income fund concentrates on stocks with market values below $7 billion; it has a four-star rating from Morningstar.

“People tend to overlook these small and mid-cap companies,” said Jill Cuniff, president of Edge Asset Management, which runs the fund.

The fund has been focusing on Business Development Companies, or BDCs, for example, which invest in small and mid-size companies. Cuniff expects these companies to grow due to stiffer regulations at competing big banks.

BDCs are structured in a way that allows them to pass on most of their earnings to investors without paying corporate income taxes. That means they can offer dividend yields as high as 9 percent, though their stock prices have also been volatile in recent months.

To be sure, smaller dividend stocks are not sure things. A big run up in prices for the smallest stocks during this bull market means they generally look more expensive than large-cap stocks relative to their earnings. Small-cap stocks can also have sharper declines than bigger companies when markets are rocky.

But adherents say that dividend payers among small-cap stocks are not as expensive as their high-growth peers. They point to the pluses of dividend stocks in general:

• Returns when stock prices are volatile.

The value of dividends shone through in 2011. That year, the S&P 500 index was virtually flat after worries about the European debt crisis and a downgrade of the U.S. credit rating shook markets. But the index nevertheless returned 2.1 percent after including dividends.

• Income in a low-yield world.

Edge's Cuniff said some of the strongest demand she's seeing for its dividend-focused strategies is coming from Asia and elsewhere outside the United States.

• Commitment to investors.

Some investors find reassurance in actual cash payments from companies, particularly after the lingering effects of Enron and other accounting scandals. When a company pays a dividend, it also forces a level of discipline on its managers. CEOs are reluctant to cut a dividend for fear of a backlash by investors.

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