What I’ve noticed over the last four years of investing is that many of the popular companies that us dividend growth investors focus on tend to be large, established companies. And for good reason! These companies typically have enduring, wide economic moats due to decades of hard work building brands, increasing quality, establishing distribution networks, and selling products to the masses – thereby making sure consumers are intimately familiar with what they sell. Economic moats aren’t built overnight, and typically you have to have a large castle to warrant a large moat. This means having high quality products that people are willing to pay a premium for.
However, not all great investment opportunities are with large, established companies with decades of dividend growth. While I would always argue that one is best building the core of their portfolio around companies that fit this profile – companies like Johnson & Johnson (JNJ) and The Coca-Cola Company (KO) – I also think once a portfolio is of sufficient size it might make sense to take a little risk on a smaller company with perhaps more growth opportunities.
Many investors point to the law of large numbers as reason enough to look earnestly for opportunities in smaller, more nimble companies. After all, it makes logical sense that it should be easier for a small company to grow faster than a large company. The problem is that small companies typically have different risk profiles. It’s obviously much easier for a $500 million company to go bankrupt than it is for a $50 billion company. So as I pointed out above it’s important to be aware of this risk and invest accordingly.
Today, I’d like to point out one small company with a solid entry yield and burgeoning dividend growth record that has the potential to one day become a big company.
Orchids Paper Products Company (TIS)
TIS is a paper products manufacturer, including paper towel, napkins and bathroom tissue. It produces products for private-label per its clients specifications, or under its own brand names – including Colortex, My Size, Velvet, Big Mopper and Linen Soft among others. The company was formed in 1998.
TIS mainly sells its products to dollar stores in hopes to catch the value conscious consumer. Whereas TIS doesn’t operate under the assumption that its brand names have any particular recognition or strength, it hopes to make up for that in price and value alone.
Hence, TIS has a strong relationship with discount retailers. Dollar General Corp. (DG) and Family Dollar Stores, Inc. (FDO) together account for 62% of the company’s sales. Wal-Mart Stores, Inc. (WMT) is the third largest customer, accounting for approximately 12% of the company’s sales in 2012.
Growth has been fairly strong over the last few years. Since 2008, EPS has grown by a compounded annual rate of 10.8%. Net income is up by almost 100% over this time frame, but revenue has grown at a slower pace by only 2.9% annually. TIS continues to operate under a favorable debt structure, with a current debt/equity ratio of only 0.2.
What’s especially attractive here for a dividend investor is the current high entry yield at 4.53%. The payout ratio is a bit concerning at 91.5%, but one would hope that growth in underlying operations would allow the growth of the dividend to be sustainable over the long term. The dividend growth has been particularly impressive over the last few years. The company initiated a dividend in 2011, and has grown it from $0.10 per quarter to the current payout of $0.35 per quarter. That’s a CAGR of 87% over the last two years. Obviously, we’re not looking at a lengthy track record like many of the major companies that make up the bulk of my portfolio, but every record has to start somewhere.
TIS shares are currently trading hands for a P/E ratio of just over 20. That’s at the upper range of what I’m usually willing to pay for a stock, but it’s a bit interesting here for TIS. What you have is a a small-cap stock trading for the same P/E ratio as many large-cap stocks like PepsiCo, Inc. (PEP), but with theoretically more potential growth due to its small size. It’s almost as if it’s a growth stock and a value stock all rolled up into one, with a hefty dividend as icing. It’s really an interesting play.
I valued shares using a Dividend Discount Model analysis and used a 10% discount with a 7% long-term growth rate, which is comfortably below the EPS growth rate over the last five years. This gives me a fair value on shares of $50. Seeing as how shares are currently trading for just under $31, there appears to be a margin of safety here. However, one must keep in mind that this is a very small company with a relatively short operating history. So the risk is amplified.
Overall, I like what I see with TIS. I can see a spot for a small company like this in my portfolio now that I have a large base of large, strong companies with enduring competitive advantages. Furthermore, I can see the demand for private-label and value priced paper products continuing. No matter your income level, you need to have bathroom tissue. However, the high payout ratio and short operating history gives me pause for now. This is a company I’ll continue to watch.
How about you? A fan of small cap-dividend payers like TIS?
Full Disclosure: Long JNJ, KO, WMT, PEP
Thanks for reading.
Photo Credit: Teerapun/FreeDigitalPhotos.net
I too will be buying high risk high reward company once I have a solid core portfolio, but I won’t do this until I been investing for 5 years. enjoyed the post and TIS looks promising.
That’s an interesting investing idea. I think you are right in stating that since you are young you can handle a little more risk. Since it’ll be a small fraction of your portfolio, I think it’s worth the risk.
I’ve taken a different route to assuming more risk. I decided a while back to pick up shares of AAPL, which, as you well know, does not have a track record of paying dividends. The company is so large and so darn awesome that I am willing to assume that risk. I bought when shares dipped to the low $400’s, so it has worked out well for me so far.
Hello DM,
Have you looked into Morning Star Dividend Growth Investor Newsletter: http://mdi.morningstar.com/? Do you think it is worth investment to get insights into dividend stocks?
I’m wanting to start learning more about some small/mid cap DG companies as the growth can be really elevated and the potential for huge total returns is there. Has anyone compared the quality? I don’t want to skimp on TP, paper towels and napkins though I’m fine with going with the cheapest.
Interesting find…not one that I have come across before.
I can think of three potential outcomes for a company in this situation:
1) They continue to grow earnings and reward shareholders with increased dividends
2) They continue to grow earnings and are bought by CL or KMB to be re-branded as Bounty, Viva, Charmin, etc.
3) They fail to remain competitive with the more established products and disappear
I won’t guess at the likelihood of any of those happening but either 1 or 2 (or both!) seem possible based on their performance over the last few years.
Interesting find Jason. Here’s two more statistics that make it even more interesting. Insiders own 28% of the stock. Also, it has nearly as much cash as debt. I’ll look into this one a little further. Thanks for the heads up, but yes I love to find small cap dividend growers. They have room to run and are under-followed by analysts!
-Bryan
Good find! If an investor has the knack to pick a good small cap company, it can make him a lot of money in a very short time! Who knows where this might be 10 years from now! 🙂
This one has been on my radar for some time, but I haven’t popped on it. Yeah, I think that high payout ratio is what has me spooked. But I’ll keep it on the radar. Thanks for the article.
Interesting find indeed, I am already invested in PKG, which is sort of in the same industry…
Regards,
Joe
FFdividend,
I think you’re making the right choice building a strong core before looking into smaller, riskier plays like this one. Nice move!
Glad you liked the post.
Best wishes.
Spoonman,
Great points there. I didn’t even bring up the fact that I’m still young. That’s a great addition to what I was saying.
Nice move on AAPL. I can’t imagine going wrong with buying shares in that company on the cheap. Although there are fears over their margins, people go crazy for their products. It’s just a matter if they can continue to innovate or not from here. Best of luck with it!
Best regards.
Anonymous,
I’m a big fan of Josh Peters. I think he and I share very similar investing styles and thought processes, so although I haven’t personally used the service I feel comfortable recommending it.
His book is also pretty solid!
Take care.
Pursuit,
I’ve never actually seen their products anywhere near me, so I have no personal experience to relate their quality. From what I understand of the company, most of their sales are located within about 1,000 miles of their mill (in Oklahoma). Tons of room for growth, but also concentrated sales. This one is a very interesting play. Obviously, a lot of risk for potentially outsized rewards.
Cheers!
Mark,
I think you laid out the potential outcomes pretty succinctly there. I agree.
I think option three is more likely than you might think, which is why I regard this as a particularly risky play. In fact, the company was formed out of the assets of a prior company that went bankrupt. Just something to think about. 🙂
Thanks for the perspective. I appreciate it!
Best regards.
Bryan,
Wow. Nice stats there. I actually wasn’t aware of the insider ownership. Awesome!
The balance sheet is actually quite strong, especially for such a young, small company. There are some compelling reasons to own a piece of this company, but then there are some major drawbacks as well. It’s definitely one to watch!
Take care.
moneycone,
I’m with you. Getting in with a small company that’s growing fast can boost your returns significantly.
I’ll be keeping an eye on this name.
Best wishes!
Chris,
Glad you liked the article.
There are some metrics that are really exciting, but then others that are indeed spooky. I’m just a bit too conservative to invest in this one at this moment, but that could change in the future.
Cheers!
J.A. Saglimbeni,
I’ve never looked at PKG. I’ll have to take a peek. Thanks! 🙂
Best regards.
DM, I think it is a safe play with TIS. It is generally a good strategy to be buying main supplier of a big chains and I like your selection. I think this will be a great trade.
I do sometimes same thing by buying more speculative stocks to pepper up otherwise “boring” dividend investing.
Hi DM, great post! I understand about the perceived risk with a smaller company or a non-recognized brand. I have some other positions in smaller companies that seem to do well, so far! At this point in time, however, I have a long list of places I would put extra cash when it comes down the pipeline, I will, however, watch TIS and see if doesn’t leap out and grab me as some of those positions fill up, thanks again!
ps – remember to hold a degree of liquidity in your investment quest, here is a snippet from Mr Buffett: “In September 2008, we came right to the abyss. If Paulson and Bernanke had not intervened, in two more days it would have been all over. BRK always has $20 billion or more in cash. It sounds crazy, [you] never need anything like it, but some day in the next 100 years when the world stops again, we will be ready. There will be some incident… it could be tomorrow. At that time, you need cash. Cash at that time is like oxygen. When you don’t need it, you don’t notice it. When you do need it, it’s the only thing you need. We operate from a level of liquidity that no one else does. We don’t want to operate on bank lines.”
My statement about liquidity is more about me never wanting to feel pressured (or forced) to liquidate a position because cash is needed. It is a lesson to me I need to revisit more often than not as my discipline in that area lapses from time to time!
For anyone interested, check with your local library if they have a subscription to Morningstar online research, where I found access to the Dividend Growth newsletter and others.
Thanks for the recommendation Anon, I forgot all about Morningstar’s newsletters!
I think I’m going to hold at this point.
Martin,
I don’t really find dividend investing boring at all, but I can see how some others might. I really find all of this stuff fascinating. I guess I’m just easily entertained! Makes it easy to live frugally. 🙂
I’m not sure about TIS. I think the risk is high, but so are the potential rewards. Any play on TIS, in my opinion, would be best as a small investment, and even then you’d want to keep a close eye on it.
Best wishes.
Katz,
I hear you on having other places to put cash. There have been many investments over the years that I was highly interested in, but there’s so many stocks and so little capital.
Let me know if TIS leaps out at you. I think it’s definitely an interesting play.
Best regards!
Katz,
Great points there. I agree on liquidity. I usually hold at least four or five grand on hand, which combined with dividends could get me by for probably five or six months. However, I recently made a large purchase that dwindled my cash reserve. I’ll be sharing the info soon!
Take care.
Wallet Engineers,
Can’t blame you. Seems like a logical conclusion. 🙂
Best regards.
Monty,
UL is near the top of my watch list. I really like the company. I recently took a good look at it and I really didn’t see anything I disliked. I wish it was cheaper, but I always wish everything was cheaper! 🙂
Best regards.
hey wanted to bounce this off you if you’re around! what do you think about BK? been starting to read up on them. I think it’s a well positioned bank for the future.
Dan,
To be honest, I don’t follow the company. However, just taking a quick look and I see a yield that’s too low for me, especially for a bank. Could do well, though. I wish you luck if you invest in them!
Take care.
I agree. Balance/Diversification is very important. You are definitely a seasoned investor!
Interesting article. I personally wouldn’t be interested in a company like this. It seems too much like a commodity type company. Also not a fan of the payout ratio and being in the generics market scares me. I’m a big sissy when it comes to investing!
Unilever seems like one that could be on the cusp if I had to guess, but I’m not the sharpest tool in the shed.
What are your thoughts on JNJ at current levels. I want to add it as a core holding. I have been watching V, MA, and JNJ and at 30 yrs old I have a time frame of 20-40 years for it to grow.
Love your blog, I’m a frequent visitor.
Stephen J,
Thanks for stopping by! I really appreciate your readership. 🙂
I think JNJ is a fair buy right now. Not overtly expensive, but not cheap either. I honestly don’t think you’ll go wrong buying it here, and I highly doubt you’d be anything but joyous 20 years from now. However, is it the best possible use of your cash at today’s prices? That could be debated. Certainly there’s a quality premium there.
V and MA are interesting. The growth rates have been tremendous. However, I continue to read stories about disruption in the industry from new players in mobile payment systems. You wonder if this industry isn’t ripe for change seeing as how technology is changing rapidly and retailers are clamoring for smaller fees due to tight margins. It’s something to watch, however I also think MA and V are entrenched here and stand to do well over the intermediate term.
I hope those thoughts help.
Best regards!