2 stunning small-cap dividend stocks I’d buy today

These small-cap stocks could be due for a re-rating, says Roland Head.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The magic of investing in successful small-cap stocks is that they can often grow into much larger companies than you might expect. And if they operate in a field dominated by larger firms, there’s always the possibility of a takeover bid.

I believe both of these potential attractions apply to the two companies I’m looking at today.

A smart acquisition

Packaging firm Macfarlane Group (LSE: MACF) has announced plans for a step change in the size of its operations. The company will pay up to £16.75m to acquire Nottingham-based peer Greenwoods Stock Boxes Limited.

The deal will be funded with a mix of cash and new shares, and as part of this process Macfarlane will raise £8m in a share placing to help fund the deal. Although this creates some dilution for shareholders, the firm still expects Greenwoods to make a positive contribution to earnings in the first full year of ownership.

This acquisition certainly seems attractive to me. Greenwoods generated an operating profit of £1.6m last year from sales of £14.1m. That gives the firm an operating margin of 11%, more than twice the 4.9% margin generated Macfarlane’s 2016 operating profit of £7.8m. So this deal should help to lift the combined company’s profit margin, boosting future returns.

If Greenwoods fails to perform as expected, Macfarlane will be able to claw back £3.25m in cash, as this will only be paid if certain trading targets are met over the next year.

Cross-selling opportunities

Management says that there is “minimal overlap” between the two companies. They expect the combined group’s shared customer base to provide new selling opportunities, which sounds positive to me.

Macfarlane stock currently trades on a forecast P/E of 11, with a prospective dividend yield of 3.2%. If Greenwoods performs as expected, I believe there’s scope for decent gains over the next couple of years. I’d rate this stock as a buy after today’s news.

Due for re-rating?

I have to admit that the performance of electric shower and bathroom fittings group Norcros (LSE: NXR) has been a little disappointing in recent years. This firm owns brands such as Triton Showers, Vado, Jonson Tiles and Croydex and operates in the UK and South Africa.

Despite generating stable profits, reliable dividends and strong cash generation, the company’s shares trade on a forecast P/E of just 6.1. One reason for the market’s caution may be the group’s pension deficit. At £62.7m, this is quite large when compared to the market cap of £104m.

However, this deficit is largely the result of ultra-low bond yields. If the Bank of England raises interest rates as expected in November, bond yields could strengthen. In common with many companies, Norcros would only need a relatively small increase in bond yields for its deficit to fall significantly.

In my opinion, this is fundamentally a good company, with a robust business and good long-term growth potential. I think it makes sense to keep the faith for a little longer yet.

Based on last year’s figures, I expect this year’s forecast dividend yield of 4.5% to be well covered by free cash flow. And as I’ve already mentioned, a low forecast P/E of 6.1 means that Norcros stock has scope for re-rating if it can deliver on growth forecasts.

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 Norcros. 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.

More on Investing Articles

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

Is Rolls-Royce’s share price an irresistible bargain?

Is Rolls-Royce's share price the FTSE 100's greatest bargain today? Royston Wild explains why he would -- and wouldn't --…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Is the Vodafone share price a wonderful bargain or a horrible value trap?

As the Vodafone share price continues to fall, is it now a stock to buy with a view to a…

Read more »

Hand of a mature man opening a safety deposit box.
Investing Articles

I’d buy 95,239 shares of this banking stock to generate £200 of monthly passive income

Muhammad Cheema takes a look at how Lloyds shares, with a dividend yield of 5.9%, can generate a healthy monthly…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

Can FY results give the Antofagasta share price a long-term boost?

The Antofagasta share price has had a good five years. Now the company says it's set to enter a new…

Read more »

Person holding magnifying glass over important document, reading the small print
Dividend Shares

Can I make sustainable passive income from share buybacks?

Jon Smith notes the rise in share buybacks from FTSE 100 companies, but flags up why they aren't great for…

Read more »

Front view of a mixed-race couple walking past a shop window and looking in.
Investing Articles

After the Currys share price rockets, here are more potential UK takeover targets!

The Currys share price has surged 39% higher in response to news of a takeover bid. Which UK stocks could…

Read more »

Investing Articles

Down 25%, where will the British American Tobacco share price go next?

The British American Tobacco share price has taken a hit. But this Fool isn't deterred. He think's now could be…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

2 cheap dividend stocks I’d snap up in a heartbeat!

This Fool is on the look out for quality dividend stocks and earmarks these two firms as great options to…

Read more »