You've probably heard it before. Small caps are too volatile. They're also a great way to lose a lot of money in a short amount of time. And don't forget, they're usually illiquid, making regular investors vulnerable to the actions of big institutional fund managers.
These are the words of the naysayers -- investors who don't understand that even though companies with market caps of less than $2 billion may be tiny compared to Wal-Mart (NYSE: WMT) and McDonald's (NYSE: MCD), many small caps have long histories as industry leaders and fantastic dividend payers.
Small caps have produced mind-blowing gains in the past 12 years, returning 153% against the S&P 500's 9%. Take a look at the amazing chart of the iShares Core S&P Small-Cap ETF (NYSE: IJR) -- an exchange-traded fund (ETF) that tracks the performance of the S&P 600 SmallCap Index.
But it's not all about capital gains with small caps, because many also carry sizeable dividends. Almost 100 stocks from the S&P 600 carry yields of more than 3%. That's better than many notable blue chips, including IBM (NYSE: IBM), which yields almost 2% and even Coca-Cola Co.'s (NYSE: KO) 2.7% yield. And because we're talking about small-caps, they have a better likelihood of growing rapidly, which in turn not only leads to share price gains, but dividend raises.
[Combining dividends with growth is one part of the "Dividend Trifecta" strategy Amy Calistri uses in her Daily Paycheck newsletter. Simply put, this strategy multiplies the effectiveness of every dollar you invest. You can learn more here.]
Here are three high-yielding small caps that offer a compelling combination of growth and income.
|Prospect Capital Corp. (Nasdaq: PSEC)
Market cap: $1.86 billion
Dividend yield: 12.5%
Prospect Capital is a private equity firm with a monstrous dividend yield of roughly 12.5%. The most recent round of dividend increases represented the 53rd and 54th consecutive cash distributions to shareholders, a testament to this small cap's ability to stay nimble in different kinds of markets. These dividends and distributions are complimented by strong earnings and a compelling valuation, with shares trading at just seven times forward earnings, almost a 50% discount to its peer group average of 13.2 times.
|Medical Properties Trust Inc. (NYSE: MPW)
Market cap: $1.6 billion
Dividend yield: 7%
Medical Properties is a real estate investment trust (REIT) that specializes in developing, leasing and managing health care facilities. Some of the highest yielding small caps are REITs, and that shows up here with the company's impressive 7% yield. REITs differ from other investments as they are required to pay 90% of earnings as distributions to shareholders. With an aging population creating more demand for health care services, analysts are calling for earnings growth of 20% in 2013, almost twice the industry rate of 10%. But in spite of this bullish growth projection, Medical Properties still has value, trading at just 13 times forward earnings, a discount to the real estate market average of 16 times.
|B&G Foods Inc. (NYSE: BGS)
Market cap: $1.5 billion
Dividend yield: 4%
B&G Foods manufactures and sells food products in the United States, Canada and Puerto Rico. Although this 4% dividend yield is the smallest of the three stocks mentioned here, it's still more than twice the return of the 10-year Treasury note's 1.7% yield and ahead of large-cap food companies such as Archer Daniels Midland (NYSE: ADM), which yields roughly 2.5%, and Conagra Foods's (NYSE: CAG) yield of about 3.4%.
On the growth side, B&G Foods has been cashing in on rising demand for food, with earnings expected to climb 29% in 2012. Shares currently trade at 22 times forward earnings, but that great dividend makes up for its slightly high valuation.
Risks to Consider: Even though these are well-established companies, small caps are still relatively more volatile than large and mega caps. Small capital inflows into large caps during times of market stress can weigh heavy on companies valued at less than $2 billion.
Action to Take --> These three small caps are mature stocks with market-leading positions, strong sales and income growth. When you add in a hefty dividend, these stocks are a great way to boost yield and go for long-term capital gains in your portfolio. Small caps such as these also benefit from being potential takeover targets as larger companies continue to grow through acquisition and industry consolidation evolves.