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2 small stocks paying big dividends

When investors think of dividend stocks, they tend to think only of big blue chip names such as BP, Shell and GlaxoSmithKline. But in light of recent better-than-expected UK economic data and the steadily recovering value of the pound since the Brexit vote, now may be the time to take a look at small-cap dividend stocks too.

The greater domestic focus of smaller companies suggests the sector stands to benefit more from improving sentiment towards the UK economy. And as an added bonus, many small-cap stocks have greater scope for dividend growth because of their more attractive earnings outlooks and higher levels of dividend cover.

Now, let’s take a look at two high-yielding small caps I think deserve a closer look.

Strong underlying fundamentals

Interserve‘s (LSE: IRV) shareholders have had a bumpy ride over the past year. While its shares have rebounded about 38% since the release of its first-half earnings in August, they’re still down by 27% over the past 52 weeks. The support services and construction group made a pre-tax loss of £33.8m in the first-half, but news that it would be exiting the troubled energy and waste sector and strong underlying fundamentals elsewhere left investors sanguine about the company’s future growth prospects.

The company has a strong domestic focus, with more than 80% of its revenues coming from within the UK, and its sizeable market position in the defence and infrastructure sectors suggests the company is well positioned to benefit from future growth in public service outsourcing demand. The government is keen to promote greater private sector involvement in these sectors, as it seeks to deliver more value for less money, and conditions are ripe for more services to be put out to tender.

Despite weak capital spending in energy markets and cost overruns in respect of its Glasgow energy-from-waste project, Interserve’s 5.6% dividend yield seems secure. Most of its markets are performing well, with the company’s gross operating cash flow up more than sixfold and net debt reduced by £33.2m in the six months to 30 June. Interserve also secured some major contract wins this year, and has a backlog worth £7.6bn, equivalent to more than two years’ worth of revenues. The projected dividend cover for 2016 is 2.5 times, with dividends forecast to grow between 2% and 3%.

Resilient consumer confidence

Clothing retailer and hire specialist Moss Bros (LSE: MOSB) is set to benefit from the resilience in consumer confidence in the UK. Businesses may have become more pessimistic with their outlooks on future growth following the Brexit vote, but consumers, who have yet to feel any real impact of Brexit, continue to spend freely.

The company has a solid balance sheet and its low capital spending needs mean it can maintain a high dividend payout ratio. With an annual dividend 5.55p per share, the stock currently yields an eye-popping 5.8%.

City analysts expect Moss Bros will deliver earnings growth of 7% this year, with a further 6% growth pencilled-in for 2017. Based on those estimates, its forward P/E would be 18.8, dropping down to 17.8 by 2017. Meanwhile, dividends are forecast to rise by 4% and 5% for 2016 and 2017.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.