2 small-cap dividend stocks that could smash the Footsie this year

Roland Head highlights two dividend-growth shares with superstar potential.

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The late Jim Slater famously warned that “elephants don’t gallop”. What he meant was that big companies are often too big to be able to grow quickly.

Mr Slater built his reputation as a top-performing fund manager by investing in small-cap growth stocks at affordable prices. I suspect that the two companies I’m looking at today would have attracted his interest, if he was still playing the markets.

Super flat, super profits

Construction equipment firm Somero Enterprises (LSE: SOM) makes machines which lay perfectly level concrete floors for large buildings. The market for this type of floor is big and it’s growing. As well as warehouses and factories, the company is now developing new machines for concrete levelling in high-rise buildings.

In a trading statement today, the firm confirmed that performance so far this year is “ahead of the comparable prior year period” and that full-year results should be in line with market forecasts.

Why I’d buy this business

Somero is the leader in this sector in the US and a number of other markets. As well as designing, selling and servicing its screed-levelling machines, it provides training and support to customers. The whole package forms a premium offering in a market where the cost of failure is very high. In my view, this firm’s customers are unlikely to switch to cheaper rivals, because the risks would outweigh any modest savings.

This is also an extremely well-run company. After entering the financial crisis with too much debt, Somero’s long-serving management team has learned its lesson and built a net cash buffer that should enable it to ride out a market downturn without any drama.

This process has been made easier by the group’s high profit margins and strong cash generation. Last year saw the firm generate an operating margin of 30% on sales of $85m. Net cash was largely unchanged at $19m, despite $13.9m of dividend payments in 2017.

Looking ahead, the stock trades on 14.5 times 2018 forecast earnings, with a prospective yield of 2.2%. If the performance remains strong, I think there’s a good chance this payout could be boosted by a special dividend.

Although the group is exposed to cyclical risks in the US construction market, I’d keep buying after today’s news.

Coming to the boil

I’m generally wary of investing in new flotations. In my view you always have to question why the previous owners have chosen this time to sell. What do they know that you don’t?

However, not all recently-floated stocks are bad. One company that’s impressed me since its flotation in August 2017 is kettle safety control maker Strix Group (LSE: KETL). This AIM-listed firm boasts a portfolio of more than 150 patents and sold its two-billionth product in November last year.

The firm’s controls are used to ensure that electric kettles switch off at the correct temperature. Strix claims a global market share of 40%. The firm says that in the UK, around 70% of kettles are fitted with its safety controls.

Competitive advantages

You might expect a business like this to be vulnerable to competition from cheaper rivals. But in most developed markets, kettle controls are regulated and must pass certification tests before they can be sold. It’s hard for potential competitors to develop equally good products without Strix’s high sales volumes.

One potential problem is copycat companies that infringe the firm’s patents. But Strix seems to have a firm grip on this. It recently announced favourable settlements with several firms that were alleged to have made or supplied products that stepped on its toes. Interestingly, in more than one case, the companies concerned agreed to start selling products fitted with Strix components instead.

A freshly-brewed buy?

The share price has risen by about 30% since the firm’s flotation. But earnings are also rising steadily. Cash generation is strong and the shares look decent value to me, on 12 times forecast earnings and with a well-covered forecast yield of 4.5%.

I’d be happy to start buying this stock at current levels, with a view to potentially building a long-term holding.

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 Somero Enterprises, Inc. 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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