2 ‘secret’ small-cap dividend stocks I’d buy for 2018

Roland Head highlights two small-cap stocks he believes could soar in 2018.

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Today I’m looking at two high-yielding small-cap dividend stocks. Both companies are being unfairly overlooked by the market in my opinion and could be good picks for 2018.

A stealthy 6% yield

AIM-listed Shoe Zone (LSE: SHOE) is a budget retailer focused on the cheap end of the shoe market.

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Shares in this Leicester-based firm edged higher on Thursday, after it said sales had fallen by 1.2% to £157.8m last year due to the closure of lossmaking stores.

And although pre-tax profit fell by 7.3% to £9.5m as a result of exchange rate losses, the market seemed reassured by net cash of £11.8m and an unchanged final dividend of 6.8p. This leaves the payout for the full year at 10.2p, giving a yield of 6.3%.

Why I like this business

One of the reasons I like Shoe Zone is that its chairman and chief operating officer, Anthony and Charles Smith, own 50.01% of the shares. Although this gives them control of the company, it should also mean that their interests are aligned with those of other shareholders.

A second attraction is that almost 85% of footwear is ordered directly from overseas factories, cutting out the middleman. This boosts the firm’s margins and gives it greater control over quality and design.

Short leases mean that the group’s store portfolio is flexible and benefits from falling rental rates on lease renewals.

A final attraction is that this business has consistently generated a return on capital employed (ROCE) of more than 22% since its flotation. That’s high by any standards, and is one of the main reasons why cash generation (and dividends) are so strong.

Of course, this stock isn’t without risk. Growth rates have been very low since flotation and currency headwinds are expected to remain a problem. But these risks are already reflected in the share price, in my view.

With the shares now trading on 10 times forecast earnings and offering a 6.3% yield, I’m seriously considering buying a few for my own portfolio.

Earnings could rise by 21%

Shoe Zone’s low rating may be a result of weak growth. But no such excuse applies to technology recruitment and outsourcing group Harvey Nash Group (LSE: HVN). Analysts expect earnings at the firm to rise by an impressive 21% in 2017/18, and by a further 22% in 2018/19.

Why then does the stock trade on a 2018 forecast P/E of 8.1? One reason may be that the market is not convinced that the group’s profits will be sustainable. That’s a valid concern, given hiring headwinds in the UK, which with Ireland accounts for nearly 40% of fee income.

A second risk is that the firm’s first-half earnings were a little mixed. Although revenue rose by 9.2% to £425m, excluding exchange rate effects, underlying pre-tax profit was only 1.8% higher, at £4m. Net debt has also risen due to acquisitions.

I’m optimistic

Analysts covering the stock have upgraded their profit guidance three times over the last year. I’m prepared to trust management guidance that performance will be stronger during the second half of the year.

With the stock trading on a P/E of 8 with a prospective yield of 5%, I believe Harvey Nash could still be a rewarding buy.

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Roland Head owns shares of Harvey Nash Group. The Motley Fool UK has no position in any of the shares mentioned. 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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