2 small-cap dividend stocks that could make you rich

Roland Head highlights two stocks with stellar income and growth potential.

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Investing in dividend stocks with a proven model for growth can be very rewarding. Even when the shares appear to be expensive, they can still offer good value due to the speed at which profits can build.

One potential example is low-cost gym operator The Gym Group (LSE: GYM). The firm’s shares rose by 6% this morning after it announced the acquisition of a rival 18-gym chain, Lifestyle Fitness.

The Gym Group currently has 97 sites and is rolling out new ones at a rate of 15-20 per year. So the addition of the Lifestyle Fitness locations should double its growth rate over the next year.

Is the price right?

Gym Group is paying £20.5m for the acquired sites. These generated earnings before interest, tax, depreciation and amortisation (EBITDA) of £3.45m over the last 12 months. That prices the deal on around six times EBITDA, which seems reasonable to me.

However, although the new sites have similar profit margins to Gym Group’s existing units, they do appear to need some work. The company is planning to spend £5.4m on updating and converting them. My calculations suggest that the total cost per site will be around £1.4m, roughly the same as the cost for the fit out of a new site.

The advantage of this approach is that Gym Group will also acquire the membership of its new sites. So they should generate a return on investment more quickly than a newly-opened site.

Time to buy?

This company’s strong cash generation means that it’s able to fund most of its rollout without debt.

Although the dividend yield is low at 0.5%, as sites mature I expect more cash to be available for shareholder returns. In the meantime, I think this business offers an exciting growth opportunity and remains attractive at current levels.

A high-yield rollout

If you’re attracted to profitable rollouts but need a higher dividend yield, then my second stock may interest you.

Hollywood Bowl Group (LSE: BOWL) is the UK’s largest operator of 10-pin bowling sites, with 56 centres around the country. The majority of these are located in out-of-town retail parks and leisure centres. Each site typically has a restaurant, licenced bar, and a games arcade in addition to bowling, so the potential spend per customer is quite high.

The firm’s recent results showed a solid first-half performance. Total revenue rose by 7.9% to £59.3m, while the group’s operating profit rose by 18.5% to £13m. This lifted the group’s operating margin from 19.8% to 21.9%, suggesting that economies of scale are available as the business grows.

These bowling complexes require fairly large sites in areas with reasonable population density. So it’s not clear to me how many sites this group will be able to open. But I think it is worth noting that leisure businesses such Hollywood Bowl are starting to become key anchor tenants at many sites, including retail parks. This could mean that the long-term growth potential of this business is greater than you might expect.

The shares currently trade on a forecast P/E of 16, with a prospective dividend yield of 3.4%. Earnings per share are expected to rise by 14% next year, giving a forecast P/E of 14. This valuation looks undemanding to me, so the stock could be worth a closer look.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Hollywood Bowl. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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