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2 dividend-paying small caps with good growth ahead

In the last 12 months, the flood of capital into the stock market has made it considerably harder to find companies trading at attractive prices. In that time, the S&P ASX 200 (ASX: XJO) index is up by over 20%. However, the S&P Small Ordinaries (ASX: XSO) is at the same level it was at a year ago. This suggests that investors will find more attractive prices if they look at smaller companies.

Small, growing companies offer the prospect of double-barrelled returns because as they grow in size the market is usually willing to pay a higher multiple of earnings. If earnings are growing, this results in considerable increases in share price.

The problem is that such companies easily become over-hyped, especially once traders and momentum investors start piling in. Smaller companies often have more volatile share prices, but a decent dividend yield can help investors ignore the share price movements, making it psychologically easier to be a long term investor.

Beyond International (ASX: BYI) has several businesses, but the most profitable is the production and copyright segment, which makes and sells television shows such as Mythbusters. Motley Fool contributor Mike King covered the company in this excellent article.

The economics of the production business can be excellent under the guidance of the right managers, and Beyond, headed by Mikael Borglund has the right team for this. Once a successful show is created, it can be milked for profit season after season with relatively little risk to the company. Besides creating its own shows, Beyond also buys the copyright to other shows and licenses them to networks.

Beyond truly is an international company, and plenty of its revenue is earned overseas. This provides further upside since the Australian dollar has weakened. The chairman, Ian Ingram, has been a major on-market purchaser of stock. Although Mr Borglund has sold stock on market recently, his transactions are dwarfed by the chairman’s purchases. This year alone, Ingram spent over $5 million buying stock on the market. In September he spent almost $3 million buying shares at just under $1.60.

Earnings before tax and foreign exchange adjustments improved in the second half of FY 2013 for the production and copyright segment and the film distribution segment. On the other hand, earnings fell in the home entertainment segment (which sells DVDs) and the loss-making digital marketing business.

At this point, it looks like it was a mistake to purchase the digital business. The barriers to entry to digital marketing are low, and the business has no obvious competitive advantage. Nonetheless, at a share price of $1.60, Beyond boasts a trailing (unfranked) dividend of 4.3% and trades on a P/E ratio of just 10.6.

My Net Fone (ASX: MNF) sells VOIP services to both retail and wholesale customers. This company provides a good example of how growing small-caps can become over-hyped. In March and then again in May of this year, My Net Fone shares traded for above $1.55. In May, substantial holder Pie Funds sold shares at these prices, and the share price subsequently collapsed to $1.10. Pie Funds sold more shares at around $1.20, which was a reasonable price based on the information available at the time.

Since then, the business has reported improved earnings. In FY 2014, the company will have a full year of contribution from three recent acquisitions and a significant contract it has with the Tasmanian government.

Higher profits in 2014 seem extremely likely, and organic growth beyond that is a reasonable proposition. It’s simply cheaper for organisations to use VOIP, and as both a wholesaler and a retailer, My Net Fone is well placed to take a greater share of this market. At the current price of $1.44, the company trades on a trailing grossed up dividend yield of 3.4% and a P/E ratio of 20.8.

Foolish takeaway

Both these companies have demonstrated a commitment to growing profits and returning capital to shareholders. Neither business is particularly capital intensive, so they are in the position to do this, and could increase their dividends in the long term. Both businesses have good economics, honest and competent management and are available at a sensible price.

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Motley Fool contributor Claude Walker owns shares in My Net Fone. Find him on Twitter @claudedwalker.

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