Should these overlooked dividend stars be on your buy list?

Dividend stocks don’t have to be FTSE 100 heavyweights. The small-cap end of the London market also contains a number of good quality dividend stocks with real growth potential.

In this article I’ll look at two such companies, and ask whether they deserve a place in your portfolio.

A turnaround buy?

Asset management firm City of London Investment Group (LSE: CLIG) issued a mixed set of results this morning. Funds under management rose by 5% to $4bn last year. Pre-tax profits were 3.9% lower at £24.4m.

Earnings per share totalled 23.3p while the firm’s 24p per share dividend was left unchanged for the sixth year, giving a yield of 6.5%. Although this payout isn’t quite covered by the firm’s earnings, City of London’s net cash of £7.2m means that this stable payout is affordable.  

Could City of London be an attractive alternative to big-cap emerging market asset managers such as Aberdeen Asset Management and Ashmore?

Looking ahead, conditions seem to be improving for the firm. The majority of its income is in US dollars, while a large part of its costs are in pounds. The weaker pound following the EU referendum has provided a significant boost to profits.

Emerging market conditions also appear to be improving in some regions. The group’s funds under management have averaged $4.3bn so far this year, up from $4bn at the end of June.

City of London’s house broker expects earnings per share to rise by 33% to 31.5p next year. This puts the stock on an attractive forecast P/E of 11.1, and should provide solid backing for the group’s high dividend yield.

At current levels, I rate City of London as a decent contrarian buy.

It’s not too late for gold

Shares in South African gold miner Pan African Resources (LSE: PAF) have already doubled this year, but I think that this well-funded firm may still have more to offer.

Pan African’s earnings were given a twin boost during the last financial year, which ended on 30 June. The firm’s average realised gold price in South African rand rose by 21.6% over the period. Alongside this, the group’s gold production rose by 16.5% to 204,928 ounces.

Unlike some larger gold miners, Pan African has a healthy balance sheet and generates strong cash flow. The group’s net debt at the start of August was just £13m, which is less than half Pan African’s forecast net profit of £33.5m for last year.

Pan African is expected to pay a total dividend of 0.61p for the year just ended, giving a trailing yield of 3.2%. The payout is expected to rise strongly during this year to 0.89p, giving a tasty 4.8% forecast yield.

The stock currently trades on 10 times 2015/16 forecast earnings. However, analysts expect earnings per share to rise by a whopping 69% to 3.08p this year, giving a forecast P/E of 6.

Although South African mining companies do face certain political risks, Pan African’s modest valuation and rising dividend yield mean that I rate these shares as a buy.

Don't ignore this income pick

Pan African and City of London both generate their earnings overseas. Market conditions appear favourable, but this could change. I believe it makes sense to have some exposure to stocks whose profits are generated in the UK too.

A good example is this company, which was recently chosen by our expert analysts for A Top Income Share From The Motley Fool.

They believe profits could be set to rise sharply at this firm.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Aberdeen Asset Management. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.