Many income investors make the mistake of avoiding small-cap stocks, despite some offering payouts to rival those of companies in the market’s top tier.
That said, it pays to be picky. Sky-high yields are often a warning sign of a looming dividend cut. With this in mind, let’s look at two market minnows and question whether investors should be tempted to dive in.
Worth the risk?
Based on its current share price, news publisher Trinity Mirror (LSE: TNI) yields a massive 7.5% this year, safely covered by profits. On a valuation of just two times forecast earnings, it’s also as cheap as chip paper to pick up.
Before pressing the buy button however, it’s important to understand why the yield is so high and valuation is so low. A quick overview of recent performance is all that’s required.
The firm’s latest update revealed an 8% fall in like-for-like group revenue over Q3. While better than the 9% drop witnessed in H1, this is hardly anything to get excited about. Local advertising revenue in particular remains “challenging and volatile“, according to the business.
Broken down, evidence continues to mount that many of us are now going online for our daily news fix. Overall publishing revenue declined by 9% thanks to a 10% drop in print sales. Advertising and circulation revenue also fell by 16% and 7% respectively over the reporting period. When things are this bad, any mention of the company performing “in line with expectations” has little impact. If expectations are low, it’s not hard to meet them.
Perhaps I’m being a little harsh here. Elsewhere in the update, the company stated that it “continues to make progress” on a deal to secure the publishing assets of Northern & Shell (owner of OK! magazine and the Daily Express). The amount of debt on the company’s books also continues to fall. This stood at £19m at the end of Q3 — far better than the £92m recorded in 2015.
Nevertheless, with business looking shaky, I’d opt for a lower payout in return for less capital risk any day.
A better income choice?
Formalwear retailer Moss Bros (LSE: MOSB) is another small-cap offering huge payouts to its shareholders. The stock yields 6.8% for the current financial year — over four times better than the top easy access savings account.
In sharp contrast to Trinity Mirror, recent numbers from this company have been encouraging. Back in September, the £92m cap reported a 2.8% rise in like-for-like sales in H1 (end of January to the end of July) compared to the same period in 2016. Pre-tax profit came in almost 16% higher at £4.2m. Early indications suggest this trading performance has continued into H2 based on a positive reaction from customers to its autumn and winter ranges.
A quick scan of the company’s financials also leaves me feeling quite positive. Moss Bros has no debt and is showing signs of generating far better returns on the money it invests compared to a few years ago. Operating margins, while slim, are improving as well.
As you might expect, however, these positives are reflected in the share price. At 16 times forecast earnings for the current financial year, Moss Bros looks expensive. Moreover, with earnings predicted to remain flat in 2018/19, prospective investors shouldn’t expect huge capital gains anytime soon.
Moss Bros remains on my watchlist for now.
Learn from the worst
Buying shares in any company based purely on the size its dividend yield is a classic investing error which, in the event of a cut, could end up costing you dear as other holders head for the exits.
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Paul Summers 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.