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These 2 small-caps could become dividend champions

If you want to make the most money from investing, the trick is to buy shares before the rest of the market catches on to their potential. Today, I’m looking at two small-caps that have the potential to be future dividend champions. It could be the time to buy-in now before it’s too late. 

Follow the money

Manufacturer of laser-guided construction equipment Somero Enterprises (LSE: SOM) is an excellent example of the rule that boring businesses tend to make the best investments.

Over the past six years, its net profit has expanded at a rate of around 80% per annum! Thanks to this growth, shares in the company have more than quadrupled in value since mid-2013

City analysts believe the group’s growth will slow over the next two years. Analysts have pencilled in an earnings per share (EPS) increase of just 17% for 2018 and 5% for 2019, a significant drop on the 80% per annum recorded between 2012 and 2017. Still, what Somero lacks in earnings growth, it more than makes up for in dividend potential. 

The shares currently yield 3.9%, but this is expected to hit 5.5% by 2019. According to analysts, Somero’s per share payout will jump 42% by 2019. With $20m of net cash on the balance sheet, and dividend cover of 2 times (for 2017) it can easily afford this growth. And I believe it could be just the start of the company’s life as an income champion because its operating profit margin of 30% gives the firm plenty of free cash flow to play with every year. Even as growth slows, management can afford to hand more cash to shareholders. 

As well as its dividend profile, shares in Somero currently trade at an attractive forward P/E of 12.5. So if you’re looking for a small-cap dividend growth play, in my opinion, this company is certainly worth a deeper look.  

Market consolidator

Another company that looks to have all the makings of a future dividend star is financial services firm AFH Financial (LSE: AFHP)

AFH is still in its early growth stages. For 2018, City analysts are forecasting EPS growth of 87%. An increase of 15% is projected for 2019. However, at this point, I believe the figures for 2019 are conservative because AFH is complementing its organic growth with acquisitions, consolidating the highly fragmented market of small wealth managers. 

Over the past seven days, it has snapped up the client portfolios of HTH Group Limited, for £5.1m (dependent upon performance) and Harvey Curtis LLP for £2.6m. Both of these acquisitions are being funded from the group’s cash resources (£24m at the end of April). 

As AFH continues to roll up smaller wealth managers, earnings should continue to multiply, building the foundations for dividend growth. 

Today, shares in the firm only yield 1.5%, which isn’t that attractive in itself. However, the payout is covered four times by EPS, so there’s enormous scope for dividend rises. I reckon now could be the time to buy into this dividend growth story, before the rest of the market realises AFH’s full potential. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Somero Enterprises, Inc. 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.