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Is Naos Emerging Opportunities Company Ltd (ASX:NCC) a buy for its 8.6% yield?

There are few shares on the ASX that have both a higher yield and a longer dividend growth streak than Naos Emerging Opportunities Company Ltd (ASX: NCC).

If we assume another 3.75 cents per share dividend for the full-year result then Naos Emerging Opportunities Company currently has a grossed-up dividend yield of 8.6%. It has increased is dividend every year since it started paying one in the second half of FY13.

However, investors shouldn’t buy just for the yield. Some shares can be yield traps like Telstra Corporation Ltd (ASX: TLS) has been.

What it is

Naos Emerging Opportunities Company is a listed investment company (LIC) run by Naos Asset Management. Over the past five years its portfolio has returned an average of nearly 15% per annum before fees but after operating expenses. Some managers only show their performance before operating expenses.

How it generates strong performance

This LIC looks to create outperformance by creating a concentrated portfolio of high-conviction ideas that it invests in for the long-term. At the end of FY18 it had nine positions. This is a small amount compared to some other managers, but it’s still better diversification for your portfolio than simply holding a single business.

The key part of this LIC’s strategy is to invest in undervalued emerging companies. This generally means businesses with market capitalisations under $250 million. It has an internal hurdle rate of 20% per annum over a rolling three-year period for its investment holdings. Obviously the returns don’t always match 20% per annum, but that’s the target.

How aligned the management are

Naos directors and employees (and related parties) own over 10 million shares of Naos Emerging Opportunities Company, which means combined they own more than 16% of the business.

Having aligned management doesn’t automatically mean returns will be better, but it does mean they want the same results as shareholders and they aren’t likely to take unnecessary risks.

Is it a buy?

Over the past year the LIC’s portfolio returned 7.13% compared to the S&P/ASX Small Ordinaries Accumulation Index which returned 24.25%. It was a huge year for the index and I wouldn’t expect the same to happen again any time soon.

I believe that the small cap space is the best place to find outperformance, so I think this Naos LIC is well worth a place in your portfolio if you want more small cap exposure. It’s trading at around its post-tax NTA, so I think it’s a good buy today. Just be aware that in some years small caps can be particularly volatile.

If you want another exciting growth idea with good dividend potential then you should read about this top business which is predicting profit growth of 30% in this financial year alone.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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