Tuesday, 20th February 2018
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John Smiles

Qualified Financial Advisor

Are smaller companies suitable for income investors?

Traditionally, income seeking investors have tended to invest in large cap stocks such as those listed on the FTSE All-Share Index. It is logical that the biggest companies should pay the highest dividends which provides the income that investors seek.

Analysis of the above Index, shows us one stock, Royal Dutch Shell, accounted for almost €1 in every €8 of all dividend payments. The top five dividend payers in the Index provide 38% of the index income and the top 15 provide 58%.

It is worrying that so much income comes from such a small percentage of stocks in the Index. Also, the concentration of the income from the Index comes from a narrow band of sectors dominated by oil and gas.

By comparison, in the Numis Smaller Companies Index, the top five dividend payers pay just 9% of total income and the top 15 pay 22%. In addition, investors have a far broader mix of companies and sectors providing dividends in the small cap area. Smaller companies therefore provide greater diversification.

Another reason to invest in smaller companies is dividend growth. Larger companies tend to have stable dividends whereas with smaller companies it is usual to see dividends grow by 10% year on year.

To get growing dividends you need to be invested in companies that are actually growing the bottom and top line and it is easier to grow a small company with turnover of €10 million a year than a large cap with turnover of €10 billion. However, investors may have to sacrifice initial starting yield in return for the prospect of greater longer-term return potential.

Large companies have seen their dividend cover come under pressure with the average dividend cover now 1.3 times earnings. Smaller Companies on the other hand have dividend cover of an average of 2.8 times earnings. Dividend cover is important because it shows whether or not net earnings will allow a company to maintain its dividend in the near future. Obviously, the higher the dividend cover the greater the chance of paying future dividends.

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