3 Small-Cap Stocks That Pay Big-Time Yields

James Brumley

When investors seek-out high-yield stocks, most of them end up finding high-profile large-cap names.

I'm talking about companies like natural gas middleman SandRidge Mississippian Trust (SDT), with its current payout rate of 17.3%, or a mortgage real estate investment trust (REIT) company such Capstead Mortgage (NYSE: CMO), which currently boasts a 10% yield. Even a more conventional equity like Dow component AT&T (NYSE: T), with its 5% yield, is sought by many investors for its reliable cash payout.

However, there's a downside to owning large-cap stocks that were built largely on the premise of paying dividends: There's little opportunity for major growth in the dividend. There's also scant opportunity for significant appreciation in the share price.

Income investors looking for overall growth that has a shot at outpacing inflation may want to consider these small caps, which have room to grow but still offer solid (and reliable) dividend yields.

OneBeacon Insurance Group
With a trailing dividend yield of 5.9%, it's not like OneBeacon Insurance Group (OB) is knocking the socks off bigger dividend payers. Throw in the fact that the stock's regular quarterly dividend hasn't budged from 21 cents a share since the insurance company began paying it in 2007 (after its 2006 IPO), and the company becomes even less impressive. Still, the yield beats the market average of 2.4%.

There's a little detail, however, that more than makes up for OneBeacon's stalled regular dividend payout. Sometimes, OneBeacon pays a whopper of a special dividend.

In 2010, the special dividend reached $2.71, translating to an effective yield of 24%. In 2011, the special dividend of $1.21 meant a yield of about 16%. That's huge.

OneBeacon didn't pay a big one-time dividend in 2012, largely because it's been shrinking by divesting some of its businesses. As the divestitures stabilize, odds are good the company will resume the special payouts. Analysts expect OneBeacon to turn 2012's loss of 59 cents a share around to a profit of $1.07 a share in 2013 and $1.13 in 2014. That leaves plenty of room to distribute more to shareholders.

Windstream
At $4.76 billion, Windstream (WIN) isn't technically a small cap, but the telecommunications company is hardly a household name. Either way, its current dividend yield of 12.5% is attractive enough to merit a closer look.

That being said, the frothy dividend yield has been subject to much debate of late. Some investors don't think it can be maintained, given the company's recent and planned capital expenditures. They need not worry. Windstream has said it's going to reduce its capital expenditures from 2012's $1.1 billion to less than $850 million this year.

Meanwhile, although Windstream continues to bleed voice-related revenue, the company is more than offsetting that with data-driven revenue. Although analysts are still expecting a mild dip in revenue this year and flat revenue growth for 2014, those outlooks don't respect the fact that Windstream has finally started to figure out its optimal collection of video, voice and data services.

Donegal Group
If Windstream is under the radar and OneBeacon Insurance is obscure, then insurer Donegal Group (DGICA) is an outright unknown. But that doesn't make it any less compelling.

Donegal shares currently boast a dividend yield of 3.4%. It's better than the market average, but investors can certainly find stronger payers. So what makes Donegal attractive?

One reason is the company's long history of rising quarterly dividends, from 6 cents a share in the middle of 2003 to 13 cents a share last quarter. The increase in the payout simply reflects growth in Donegal's revenue and earnings -- even if that growth has been erratic at times.

However, there's an X factor now working in favor of Donegal shares: a potential bidding war. Institutional-level private investor Gregory Mark Shepard has offered $30 per Class B share for enough shares to give him control of nearly 23% of the company. That was a 42% premium over the pre-offer price. The board of directors, however, advised shareholders to not take the offer.

Although it's unlikely Shepard will increase his offer, it's not off the table, either. Even if he doesn't counter with more than $30 per share, he's long argued that the company's B shares -- and by extension, its A shares -- "trade at a substantial discount to their realizable value if combined with another mutual insurer." He's also clamored "to explore strategic alternatives to maximize shareholder value." If Shepard sees something untapped about the company, one way or another, it will eventually come to the surface.

Risks to consider: Some investors will have noticed that shares of many of the market's favorite dividend payers have suffered of late, due in part to the rising yields on the 10-year Treasury note. Dividend stocks are highly rate-sensitive. Though it's unlikely bond yields have room to move much higher anytime soon, anything's possible.

Action to take --> First and foremost, investors may want to consider whether a particular industry is overrepresented or underrepresented in their current portfolio before entering any of these names. If that's not an issue with your particular portfolio, however, then Donegal may be the top choice among the three. Though it has a trailing yield of only 3.4%, it's the best positioned of the three to beef up its bottom line and increase its payout rate in the foreseeable future.

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