Yesterday I revealed my three top tips for small-cap investing success.
These three simple principles guide my decision on whether to recommend a speculative investment.
If you consider and apply that advice, you’ll set yourself up to boost your win rate in small-cap shares.
Today I want to let you in on a fourth secret. It’s a simple characteristic shared by successful emerging companies.
And it’s all about the need for companies to attract dividend-hungry investors.
You see, shareholders are a fickle bunch. Often it’s not enough for a company to reward them with share price appreciation. They want to get their hands on the company’s profits in cash. That means many investors gravitate towards stocks that pay dividends.
That’s true in markets around the world. But it’s especially true in Australia. Dividends typically bring investors here a bonus tax credit.
I’m sure you know why investors have been swinging this way. Lower central bank interest rates mean lower savings and term deposit interest rates.
That has forced investors to take bigger risks to maintain the same income level.
That means you should keep your eye out for stocks that can grow and pay rising dividends. If you spot them before the rest of the market cottons on, you’ve most likely found a golden opportunity.
Only one area of the market can meet investor demand for big growth and tasty dividends – small-cap stocks.
Companies that fit this bill are rare. I call them ‘Turbo Caps’.
These are the profitable, or soon-to-be profitable small-cap stocks that are about to pay or increase their dividend.
So, how can you identify a ‘Turbo Cap’ stock? I look for three key indicators:
- Healthy cash flows from paying money to suppliers and receiving money from customers. This is crucial. It’s hard for companies to pay dividends from an empty bank account.
- Rising revenues — and in turn, rising profits — from a genuine, growing business.
- A dividend payout of only a fraction of the company’s profits.
When I find a stock with those characteristics, it usually tells me that dividend growth could be on the cards.
That means bigger payouts for shareholders. And that means more investors will want to own the stock — which pushes up its price.
Sometimes I find a stock that’s yet to prove all three key ‘Turbo Cap’ indicators. But my analysis reveals that the company is almost there.
The company might be achieving smaller and smaller cash outflows. It might be reporting smaller and smaller losses. Or it might pay a dividend but hasn’t hiked it in years.
These stocks can be even more exciting than the full-blown ‘Turbo Caps’. They can also bring you much bigger percentage gains.
You see, if you can pick these stories before they hit those ‘Turbo Cap’ milestones, you get in on the ground floor. That means you can enjoy ripping capital growth and fat dividend yields.
As I said, companies that fit this bill are rare. You won’t find them in every sector of the Aussie stock market.
To enjoy rising cash flows, revenues and profits, a company needs a genuine product or service to sell to customers. That’s why I don’t look for ‘Turbo Caps’ among firms engaged in research and development.
And chances are I won’t look at resource companies. That’s because they can live or die by a single drill result.
Rather, I want stocks that have cash flows coming in and going out of the company. I want stocks that can grow the business so that revenues and profits go up. When you get that right, dividend growth often follows.
Sounds simple, right? Not exactly. Nothing is ever that simple.
But if you can find them at the right time, it can be a handsome reward for investors.
You should always consider dividend-paying stocks for your portfolio.
That includes blue-chip dividend stocks. But just as important, it should include ‘Turbo Caps’ dividend stocks too. That’s how you’ll give yourself the best chance of reaping capital gains while hefty dividends pile up in your pocket.
Small-Cap Analyst, Australian Small-Cap Investigator
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