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Why this 6% yielder is on my buy list for September

Investors looking for reliable dividend yields often focus on the same old FTSE 100 names. But in my view, we can often find better quality payouts among smaller companies.

To give you a taste of what’s on offer, I’m going to take a look at two potential income buys from the FTSE SmallCap index.

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58% profit growth

City of London Investment Group (LSE: CLIG) is an asset management group which invests at least 90% of its funds in emerging markets. The group’s pre-tax profit rose by 45% to £11.6m last year, while after-tax earnings rose by 58% to 36.9p per share.

However, shareholders shouldn’t get too excited by these dramatic figures. Last year’s results were given a big boost by the pound’s fall against the US dollar, and by a reduction in the group’s tax rate. Neither of these factors is likely to repeat this year, in my opinion. So does the group’s underlying performance justify further gains?

A cash-backed 6.2% yield

City of London’s funds under management rose by 17% to $4.7bn last year. Although that’s less than the 24% gain logged by the group’s benchmark index over the same period, management says that this is a result of clients taking profits on their emerging market funds and shifting some money elsewhere.

What’s certainly true is that the group’s cash generation continued to be very strong. Net cash rose from £10.2m to £13.9m last year, meaning that 13% of the group’s £106m market cap is now covered by net cash.

Cash reserves are now high enough to pay two years’ dividends at the current level of 25p per share. So the company should be able to pay a stable income through lean years as well as good years, providing more reliable returns to shareholders.

After today’s results, City of London Investment Group shares trade on a P/E of 11 with a dividend yield of 6.2%. In my view this continues to represent good value for investors looking for a long-term income. I’d be happy to buy at current levels.

Best in sector?

Continuing the theme that biggest isn’t always best, my pick of the stocks in the FTSE Construction & Engineering sector is Costain Group (LSE: COST), a £458m firm that was founded in 1865.

Unlike several of its rivals, Costain has avoided financial problems and delivered steady profit growth in recent years. One reason for this, in my view, is the company’s focus on large infrastructure projects where it can take consultancy and management roles, rather than low-margin contracting work.

To help improve its financial credibility when bidding on large projects, Costain raised £75m in a share placing in March 2014. This raised some eyebrows at the time, but has since proved wise. The firm’s revenue and its profits have both risen by more than 50% since then, suggesting management was right to strengthen the balance sheet.

Although Costain’s share price has risen by 30% over the last year, strong earnings growth means that the stock still looks reasonably priced, with a 2017 forecast P/E of 12.9 and a prospective yield of 3.3%. This company is certainly my top pick in this sector, and I believe it remains good value by any standards.

Today's top small-cap dividend buy?

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Roland Head has no position in any of the shares mentioned. 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.