5 Unloved Small Cap Stocks With Strong Dividends

https://www.forbes.com/sites/taesikyoon/2024/04/12/5-unloved-small-cap-stocks-with-strong-dividends

Sometimes you can have your cake and eat it too. Here are a fistful of equities with rich dividends, but also poised to produce ample capital gains.

_By_{Taesik Yoon}_{, Forbes Staff}

In my younger days, I shunned dividend-paying stocks. To me, they were what your father bought, what those who already had loads of money owned. In other words, these weren’t the investments you bought to get rich, they were what you wanted after you became rich.

That jibes with some of the biggest reasons why dividend-payers appeal to a large swathe of investors:

A predictable and recurring stream of passively -generated cash income.
The perception that dividend- paying firms tend to have a record of solid and stable free cash flow and responsible debt management, which also make them less risky to hold and especially attractive during market downturns.
The fact that dividends can be reinvested right away and allow you to benefit from the power of compounding, one of the most important wealth-driving concepts in all of finance.

As I’ve been fortunate enough to build some wealth over the years, I get the allure now. More importantly, these years have also taught me that it doesn’t matter how your gains come. At the end of the day, cash is cash.

Let me illustrate with an insultingly simple example. Say you have two stocks you purchased for $10 each as shown in the table below. Stock A climbs to $12 in a year for a gain of $2. Stock B ends the same period at $10 for no gain but paid out $2 in dividends over this span. Either way, your total return is the same at 20%.

Of course, this makes perfect sense. Cash represents tangible value. So, when some of it is returned to shareholders via dividends, it should decrease the value of the company and its shares by the same amount. The flipside is that the stock of a company that doesn’t pay dividends doesn’t suffer from this recurring loss in real value and will also accumulate cash more quickly as a result, which can then be reinvested to accelerate growth.

That all suggests one must come at the expense of the other, and in practice this often seems to be the case. After all, generous dividend payers tend to operate in mature industries and markets that offer limited growth potential. In fact, it’s not a stretch to say that some simply don’t have anything better to do with their excess cash production than to give it back to their shareholders. Thus, while the expectation for capital appreciation is still there, the primary motivation for buying these stocks is for the steady and predictable stream of income they provide. Conversely, a smaller firm with more favorable growth prospects would probably be better off reinvesting its excess cash to generate stronger sales and earnings, which, in turn, should result in a higher stock price.

Yet while rare, there are times when a stock can offer both. In my experience, these situations usually arise when a steady dividend-payer that was already trading at a discount to the market suffers a sudden loss in share value on overblown operational concerns stemming from a softening in its near-term prospects or in the health of the general economy. Not only does this make a cheap stock even cheaper, but it also results in a more generous dividend yield as long as the payout holds steady. More importantly, it can result in a situation where a stock becomes significantly oversold and looks very compelling from a capital gains standpoint while also offering a dividend yield that has become high enough to appeal to income-seeking investors.

But two other factors are usually required for such stocks to truly stand out. First, there must be sufficient evidence to indicate the dividend payments are safe and will even grow over time. Second, there needs to be evidence for why shares of these firms will be able to realize great value sooner rather than later.

A stock that’s both incredibly cheap and will pay handsomely while you wait for this value to come to fruition? Sounds too good to be true. That’s what makes them so hard to find. The fact is steady dividend payers don’t usually go ignored by income-hungry investors. Their interest tends to set set a floor price on such stocks that prevents them from becoming attractive to growth-oriented buyers.

That being said, as a student of fundamental analysis specializing in uncovering deeply undervalued stocks, I sometimes come across stocks with high yields and good growth prospects. Most of the time, I only care about their price appreciation potential and view any dividends as gravy. But some yields are too generous to simply dismiss. For these stocks, the recurring cash income from dividends adds real and meaningful value that significantly augments the substantial upside these unloved stocks already offer from a capital-appreciation standpoint.

Take Fresh Del Monte Produce (FDP), which is the first of five such stocks highlighted below and a name with which anyone who has frequented a grocery store should be familiar. This one has fallen about 16% over the past year while the S&P 500 has surged 26% even as its earnings rose in 2023 and is expected to continue growing this year. As a result, it now trades at less than 11 times its current consensus earnings estimate for 2024, down from more than 13 a year earlier. At the same time, the significant improvement in its financial health over this span provided the company with the confidence to raise its quarterly dividend payment by 25% to 25 cents per share in February. As a result, the stock’s yield has nearly doubled to 4%s from just over 2% a year earlier.

Fresh Del Monte Produce (FDP)

Who They Are

Fresh Del Monte Produce is a global leader in the production, distribution and marketing of fresh and fresh-cut fruits and vegetables, as well as a growing provider of value-added products such as prepared fruit and vegetables, juices, beverages and snacks. With a vertically integrated business model that allows for quality control, the company has built a reputation for high-quality, fresh produce that spans a variety of categories, including bananas, pineapples, melons, tomatoes, avocados, grapes and berries. FDP, based in Coral Gables, Florida, had sales of $4.3 billion last year and has a market value of $1.2 billion. It serves customers including retail stores, wholesalers and foodservice operators across North America, Europe, Asia, the Middle East and Africa.

Why The Stock Could Fly

FDP ended 2023 on a down note with sales and adjusted earnings in the final quarter missing their respective consensus estimates by $25.3 million and 6 cents a share. This was the second quarter in a row in which FDP’s operating results fell short. After the first miss, its stock suffered its biggest single-day drop in two years (falling $3.52 on November 1, 2023) and finished the day at just $21.41—the lowest level in three years. Thus, given the persistence of and even worsening in the softer market conditions that emerged midway through last year implied by its fourth-quarter results reported in February, some may view the subsequent selloff FDP’s stock has endured as appropriate.

But to believe this decline is justified is to ignore the substantial operational progress the company was able to make in 2023, which I expect to contribute to better results this year. This is most apparent in the improvement in the company’s financial position last year. Specifically, FDP made significant headway on its asset optimization program—which aims to improve profitability by shedding and consolidation of underutilized manufacturing capacity and non-strategic assets and related profit-driving actions. This includes two distribution centers and related assets in Saudi Arabia, an idle production facility in North America, a plastics subsidiary in South America, idle assets in South and Central America, and two carrier vessels, which collectively generated cash proceeds of $119.9 million.

At the same time, the higher earnings for the year overall—which still grew 8% from 2022—along with successful efforts to efficiently manage working capital, contributed to free cash flow of $120.3 million last year. That was a huge improvement from $13.7 million in 2022 and represented the company’s highest annual tally in seven years. Collectively, this significant cash infusion allowed FDP to reduce its net debt by $157.5 million in 2023 to just $373.7 million. This marked the company’s lowest year-ending debt balance since 2017.

Fresh Del Monte Produce (FDP) is one of the stocks recommended in our market-beating investment newsletter, Forbes Investor. To discover more undervalued gems, try Forbes Investor.

Also not reflected in the current price, in my view, is the strong gross margin of 8.2% the company achieved for the year on an adjusted basis—which is the highest since 2016, thanks to the benefits of disciplined cost controls, the greater emphasis on profitable growth (even at the expense of losing some low-margin business) and the asset optimization transactions highlighted above. I expect this to improve further in 2024 as FDP continues to increase its mix of higher-margin value-added products in its Fresh and Value-Added segment, the company’s largest business. Thus, assuming demand in its Bananas segment remains stable and its businesses benefit from a more balanced ocean- freight market, I think 2024 will prove to be a much better year for FDP and its stock.

What Makes The Dividend Safe

FDP has paid a steady quarterly dividend since 2002, which has risen from 5 cents per share to 25 cents per share. This reflects the strong free cash flows its operations have historically produced. More importantly, as the latest increase—from 20 to 25 cents was announced just a few months ago—the company clearly expects its free cash flow to be strong enough to give even more back to its shareholders while also funding all its growth initiatives.

Information Services Group (III)

Who They Are

If you watch the promotional video on the website of Stamford, Connecticut’s Information Services Group (III), you would come away thinking the $291 million (2023 revenue) company is at the forefront of every leading global technology service on the planet–from generative AI and cybersecurity to cloud transformation. The fact is, Information Services Group is one of hundreds of companies providing technology research and advisory services in a host of areas, including automation, cloud and data analytics; sourcing advisory; managed governance and risk services; network carrier services; technology strategy and operations design; change management; market intelligence; and technology research and analysis. Its customers are mainly corporations, public sector organizations and service/technology providers, and their promise to them is to help them achieve greater operational productivity, reduce costs and accelerate growth. The company has 1,500 employees operating in over 20 countries and the company claims it serves about 900 clients, with around 40% overseas.

Why The Stock Could Fly

Like FDP, III’s stock is having a tough time following a disappointing end to 2023 reported in February and is down about 18% year-to-date. Specifically, revenues and adjusted earnings in the final quarter fell 10.8% and 52.7% year over year to $66.2 million and 6 cents per share and missed consensus estimates by $2.7 million and 3 cents. The company blames the problems on economic uncertainty, which caused its customers to put off spending, as well as a rise in expenses from its own efforts to retain key staffers as it waits for business to rebound. What’s more, III reported that a delinquent Dubai-based client forced the company to incur a reserve for bad debt expense of $4.8 million during the quarter.

III’s near-term guidance also left something to be desired, with revenue and adjusted Ebitda of just $65-$67 million and $6 to $7 million forecast for the current quarter. This, too, is much lower than the $74.7 million in revenues and $10.4 million in adjusted Ebitda analysts were projecting and indicates that client demand remains suppressed into 2024.

Yet I believe a major factor that has contributed to the more sluggish pace of decision-making by its clients is the advent of generative artificial intelligence (AI), their desire to incorporate this technology into their research platforms and solutions going forward, and the uncertainty presented on how best to proceed. Undoubtedly, its clients want to be sure that their research solutions will be able to take advantage of this disruptive and potentially productivity-enhancing technology before committing to a multiyear contract. While the infancy of generative AI makes knowing how to apply and govern it more challenging, III’s clients are asking the company to embed this technology into most of their engagements.

The good news is that, III has years of experience helping clients adjust to new technologies. With regard to AI, the company launched a new Enterprise AI advisory business at the start of this year to guide clients through this intricate maze of AI adoption—one that brings its trusted experience and technology sourcing, deep expertise in AI and broad access to the provider ecosystem to create a new and unique approach to sourcing AI. To ensure III is able to get the most out of the new opportunities in this pipeline that should continue to emerge from the rapid adoption of AI technology, the company scaled up its workforce training and certified more than 1,200 of its employees in Enterprise AI in the final quarter of 2023, which actually contributed to the lower profits seen in the period.

Then there’s III’s new sourcing platform, ISG Tango, launched early in March. It automates all the elements of the existing ISG FutureSource procurement system. This new platform takes advantage of III’s extensive transaction data, provider evaluations and market insights, and it includes a virtual deal room to secure document, exchange and user interaction. Because it’s powered by AI, ISG FutureSource can provide real-time predictive insights to streamline the transaction process. It’s also expected to allow III to penetrate the underserved mid-market—which spends about $130 billion on technology and business services annually—for the first time.

I believe these AI-centric growth platforms are a big reason why III still expects to achieve its goal of expanding its Ebitda margin to 17% by 2025 from less than 13% in 2023. Thus, while this may take a bit longer to materialize than some observers anticipated when the year began, I expect it to still occur fast enough and be strong enough to make buying III’s stock at these depressed levels well worth it.

What Makes The Dividend Safe

While III has only been paying quarterly dividends since mid-2021, the company has raised the level every year to 4.5 cents from the initial 3 cents. This 50% increase speaks to the confidence the company has in its ability to produce free cash flow strong enough to cover the dividend without jeopardizing its ability to fund growth. With earnings and cash flows likely higher this year, I expect this to remain the case.

ACCO Brands (ACCO)

Who They Are

Lake Zurich, Illinois-based ACCO Brands (ACCO) is a provider of school supplies, office products and accessories for personal computers and video-games systems. This includes a wide range of notebooks, binders, planners, filing products, staplers, shredders and peripheral devices for video-game consoles and other products, which are sold under well-known brands such as Five Star, Mead, Swingline, Kensington and PowerA. In 2023 ACCO, which has a market capitalization of just under $500 million, had revenues of $1.8 billion. It distributes its products through various channels, including office supply retailers, wholesalers, contract stationers and online retailers.

Why The Stock Could Fly

Bolstered by better-than-expected demand, ACCO reported net sales and adjusted earnings per share for the final quarter of 2023 of $488.6 million and 39 cents per share, which trounced the respective consensus estimates by $12.2 million and 6 cents. However, its forecast for 2024 was less impressive. Specifically, with the company expecting demand trends to remain muted due to the uncertain macroeconomic environment, ACCO sees comparable sales being down 2.5% to 5.5% and net sales falling 2.0% to 5% from last year to $1.740 to $1.788 billion and relatively flat adjusted earnings of $1.07 to 1.11 per share. That’s well below the $1.862 billion and $1.20 analysts were projecting before the February 22 announcement and likely the biggest reason why the company’s shares are down about 15% year to date.

Yet I think this slide ignores the fact that ACCO delivered on its most important financial metric: free cash flow. Indeed, boosted by solid free cash flow production of $54.3 million in the final quarter, the company generated $117.5 million in free cash in 2023. This was up 52% from the $77.5 million produced in 2022 and easily met its initial forecast of at least $100 million in 2023. As a result, ACCO was also able to reduce its debt by $88 million in 2023 while continuing to fund its growth initiatives and dividends. This also led to a decline in the company’s net leverage ratio to very manageable 3.4 at the end of 2023 from the 4.2 at which it entered the year.

ACCO’s actions taken over the past two years to improve profitability are succeeding, with its adjusted operating margin in 2023 expanding to 11.2% from just 9.0% in 2022. With its outlook for the year indicating expansion ahead, even in the face of the projected sales decline, this boost in margin doesn’t appear to be a fluke. The same is true for its stronger cash production, which is why ACCO also expects to improve upon its impressive 2023 performance and is targeting free cash flow of at least $120 million for this year.

I believe the permanent increase in the company’s margin profile and the decline in its leverage (which remains among the biggest factor weighing on its stock) over the past year alone are enough to justify a materially higher valuation than the ridiculously low forward price/earnings multiple of less than five. And this doesn’t include any benefits from the restructuring program announced in January that is aimed at taking out an additional $60 million in annual costs through actions to simplify and delayer its operating structure and headcount reductions, supply chain optimization, global footprint rationalization and better use of the company’s sourcing capabilities. I think the much stronger profit performance this should contribute to once sales growth resumes is well worth waiting for, especially with the generous dividend you get to collect as you wait.

What Makes The Dividend Safe

As the most leveraged of the companies I’m writing about, ACCO’s dividend is probably the least safe. But the reason why the company has been able to pay this dividend even as its debt-service expense surged from the sharp rise in interest rates over the past two years is because of the solid free cash flow its operations continued to produce. As ACCO enters 2024 with even less debt than it had a year earlier and free cash flow projected to remain strong, I don’t expect the company to have any difficulty in continuing to fund its quarterly dividend payments, which have been raised twice since their initiation in 2018—to 7.5 cents a share from 6 cents—despite the challenging operating environment over much of this span.

SpartanNash (SPTN)

Who They Are

Grand Rapids, Michigan’s SpartanNash (SPTN) describes itself as a “food solutions” company. Translation: it runs grocery stores and is also a wholesaler. The company operates 144 supermarkets in the Midwest under the Family Fare, Martin’s Super Markets and D&W Fresh Markets banners and supplies food products to independent grocery store operators ranging from single stores to large regional supermarket chains, as well as to 160 military commissaries and more than 400 exchanges worldwide. Through its 19 wholesale distribution centers, SPTN offers approximately 90,700 separate stock-keeping units (SKUs), which include nationally advertised brands and thousands of products sold under its own private labels (think higher margins) such as Our Family, Open Acres, Crav’n Flavor, Culinary Tours, Full Circle Market, PAWS Happy Life, Pure Harmony, Simply Done, That’s Smart!, Tippy Toes, TopCare and Wide Awake Coffee. In 2023, the company had revenues of $9.7 billion and its market capitalization currently sits at around $650 million.

Why The Stock Could Fly

No stock I’m writing about has fallen more since the end of 2022 than SPTN. Indeed, it sank 24% last year alone, vastly underperforming the S&P 500, which gained the same amount. The 2024 decline of 18%, brings that drop to 37%.

I’ll be the first to acknowledge that some of this has been warranted. After all, not only did SPTN end 2023 on a weaker-than-expected note—with net sales and adjusted earnings of $2.25 billion and 35 cents per share in the final quarter missing their respective consensus estimates by $25.1 million and a penny—but the company’s forecast for adjusted earnings of $1.85 to $2.10 per share for this year also fell well below the $2.41 per share that the Street was looking for.

That said, things also aren’t as glum as they may appear. In particular, the slight earnings shortfall to end 2023 was driven by greater-than-expected noncash depreciation and amortization expense, which does not reduce cash flow, resulting from the sizable increase in SPTN’s total depreciable asset base after a spate of capital spending over the past year to support its growth strategy. Stock-based compensation costs, which most firms actually exclude from their reported earnings (as they too are noncash in nature), were also much higher. I estimate that the rise in these costs reduced earnings per share by roughly 6 cents. But because they aren’t actual cash expenses, they had no impact on cash flows.

This is also why I don’t find SPTN’s forecast for 2024 all that disappointing. In fact, the midpoint of the company’s $255 to $270 million adjusted Ebitda guidance of $262.5 million—which excludes the noncash items noted above—was actually higher than the $255.9 million consensus. Thus, from a cash flow standpoint—which I believe is a far greater determinant of a stock’s worth than reported earnings—not much has changed.

In addition, the guidance implies SPTN’s plan to raise adjusted Ebitda to $300 million a year by 2025 is still on track. The company is investing in automation, AI and supply-chain initiatives to achieve that goal. In fact, there are plans for additional cost cuts of $50 to $60 million this year. As these savings materializes, I expect it to trigger a sizable rebound in SPTN’s stock.

What Makes The Dividend Safe

SPTN has paid quarterly dividends for nearly two decades, which have steadily risen to 21.75 cents a share from an initial payout of a nickels. This reflects the generally stable cash flows produced from the non cyclical nature of demand for the products sold at its retail stores and distributed by its wholesale operations. And while the last increase—of a quarter cent—was minimal, the fact that the company raised it at all suggests that these payments are quite safe.

Ituran Location and Control (ITRN)

Who They Are

Israel’s Ituran Location and Control (ITRN) provides vehicle-tracking services, using technology (telematics) developed for the Israeli military to locate downed pilots. Much of its business is helping recover stolen automobiles, and it also provides fleet management as well as connected car and usage-based insurance applications that require secure high-speed data transmission and analysis. Its products and services are used by retailers, insurers and car manufacturers in countries including Israel, Brazil, Argentina, Mexico, Ecuador, Colombia, the U.S. and Canada. Ituran produced $320 million in revenues in 2023 and has a market capitalization of about $530 million.

Why The Stock Could Fly

This stock is a little different than the four others presented here—while all the rest have underperformed the market over the past 12 months, ITRN shares have fared relatively well and are actually up about 22%.

But in my view, the stock should be up a heck of a lot more. After all, despite the war between Hamas and Israel (where the company is based), as well as pressure from the devaluation of the Argentine peso, ITRN’s earnings in the final quarter of 2023 met the consensus estimate as gross margin in its Products segment held up better than expected. What’s more, the company produced $17.7 million in free cash flow. That more than doubled the $8.2 million generated in the corresponding prior-year period and allowed ITRN to end 2023 with a net cash balance of $53.million, more than triple the $15.3 million it had a year earlier.

Prospects for 2024 are even brighter. Based on ITRN’s preliminary guidance, net new subscriber additions is expected to remain strong at 35,000-40,000 a quarter as it benefits from increases in Israel’s new car sales rate, more insurance companies and automobile owners looking for location-based security systems, and from the marketing of its products to financial services firms that provide loans to buyers of new vehicles in emerging markets. Factoring in the higher subscriber base, which was up 9% from 2022, this portends another year of solid top-line growth that the company sees translating into $90 to $95 million in Ebitda. At the midpoint, this implies record earnings that comfortably exceed the $2.50 a share analysts were initially forecasting.

ITRN is also confident in subscriber growth beyond 2024 and is already targeting more than $100 million in Ebitda for next year, which implies an acceleration in profit growth. This confidence can also be seen in the decision by ITRN to increase its quarterly dividend payout for the second consecutive quarter to $8 million from $5 million in the third quarter and $3 million in the preceding period. Yet even with this increase in payout, which now stands at 40 cents a share, I expect free cash flow production and its cash pile to grow.

In my view, a company that has enough confidence in its future prospects to nearly triple this recurring cash commitment in six months, is forecast to enjoy the highest revenue and earnings in its history in 2024 and also began the year with its strongest net cash position since 2011, shouldn’t be trading at less than 11 times its consensus earnings estimate for the current year and at such a massive discount to an S&P 500 that is now trading at more than 21 times its aggregate earnings forecast for 2024.the overall market. If ITRN delivers on its operational expectations, it probably won’t be for long.

What Makes The Dividend Safe

As noted above, ITRN has increased its quarterly dividend payouts by 167%—from an aggregate amount of $3 million per quarter to $8 million (roughly 40 cents per share)—in just the last two quarters. That means unlike most of these other stocks whose higher yields were driven by a steep corresponding drop in share value over the past year, the reason why ITRN’s dividend yield has doubled in the same span is because the payout has increased much more than the company’s stock price. While I don’t see that continuing in the near-term, I fully expect further increases down the road if ITRN delivers on its longer-term profit growth targets.

The brain trust at Forbes has run the numbers, conducted the research, and done the analysis to come up with some of the best places for you to make money in 2024. Download Forbes’ most popular report, 12 Stocks To Buy Now.