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Two small cap stocks with unmissable dividend yields?

If you only focus on big-cap stocks for dividends, then you may be missing out. The UK market contains a number of high quality small-caps with very attractive yields.

Smaller companies aren’t always high-risk growth plays. They can be well established, durable businesses with good cash generation.

In this article I’ll take a look at two with high yields, currency hedging specialist Record (LSE: REC) and retailer Laura Ashley Holdings (LSE: ALY). Record currently offers a forecast yield of 6.3%, while Laura Ashley’s prospective yield is an incredible 9.6%.

Are these yields backed by free cash flow and earnings? Are they sustainable? Why are they so high? These are the questions we need to answer.

Floral furnishings generate cash

Laura Ashley has cranked out stable results in recent years. A lack of debt and limited capital expenditure has meant that cash generation was strong. The group’s policy of paying out almost all of its earnings as dividends was affordable.

This comfortable picture changed somewhat last year, when Laura Ashley took out a £24m loan to buy a new Asian headquarters building in Singapore.

To make matters worse, profits are also expected to fall significantly this year. The latest forecasts from the firm’s house broker suggest that earnings per share will fall by 28% to 1.8p in 2016/17. The dividend is expected to fall from 2.5p to 2p per share, giving a 9.6% prospective yield.

I suspect this dividend will be paid, but having looked at the firm’s accounts for last year, I think that Laura Ashley will probably have to draw on its cash balance to make this payment. Unless earnings rebound strongly during the following year, I believe this supersized dividend could come under pressure.

Are cash returns on the horizon?

Record specialises in managing exchange rate risks for its clients. It’s a niche business that appears to have limited growth prospects. However, Record’s specialist skills allow it to charge high prices. These translate into an operating margin of more than 30%.

A lack of growth expenditure means that Record has built up a £34.7m net cash pile. This amounts to 15.7p per share — more than half of Record’s £59m market cap.

A trading update today confirmed that Record’s full-year results are likely to be in line with expectations. Forecast earnings of 2.24p per share should cover the 1.65p dividend comfortably.

Record’s management has also indicated that in the absence of major growth opportunities, it may consider returning surplus cash to shareholders.

In my view, Record’s latest accounts and trading guidance make it clear that the stock’s 6.3% yield should be very safe for the next few years. Indeed, income from this stock could rise significantly if Record decides to start returning surplus cash to its shareholders.

I see Record as an interesting income buy with the potential to generate a lot of cash. The only risk is that cash returns and a lack of growth may gradually erode the value of the shares. That could be something to watch out for over the next few years.

This small-cap offers income and growth

The most obvious weakness with both Laura Ashley and Record is that their growth prospects are uncertain.

If this concerns you then you may be interested in learning more about the stock featured in our latest report, 1 Top Small-Cap Stock From The Motley Fool.

The company concerned appears to offer an attractive blend of growth and income at a very attractive valuation. Our experts are very excited about this opportunity. If you'd like know more, please download this FREE, no-obligation report today.

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