One useful way of finding undervalued companies is to look at dividend yields. From time to time, I like to look at a list of all the ASX companies, ranked by dividend yield. Many companies that have a really high dividend yield have something wrong with them. But some companies with great businesses will usually show up with a yield above 5%.
For example, G8 Education (ASX: GEM) showed up on one such list around the middle of 2012. At the time, G8 Education was a small, growing company boasting a dividend yield of 5.2%. Unfortunately, I didn't buy shares in the company, which are up more than 300% since then! I've run a similar list today. Here are three of my favourite small caps, yielding over 5%.
1. Hansen Technologies (ASX: HSN)
Hansen was founded in 1970 and floated in 2000. Change is in the DNA of this company, but one thing is constant (since 1986, at least) — the company specializes in billing systems. Hansen pays a dividend of 5.35%, mostly franked. Last year the dividend was not entirely franked because of a fall in Australian earnings.
Hansen's major clients include electricity retailers. The advent of smart metering means that electricity bills will become increasingly complex, widening Hansen's moat. Recent acquisitions of foreign companies mean that Hansen will benefit from a falling Australian dollar. This is a high quality company that earns good returns on equity. The worst investment decision I made in 2013 was to sell my shares in Hansen Technologies.
2. RCG Corporation (ASX: RCG)
RCG Corporation is an underrated retailer that operates under the Athlete's Foot brand. RCG shares are up almost 10% to 79 cents since I started writing this article on the weekend. Rather than a conspiracy to undermine my stock picking, the market has boosted RCG because the company announced on Monday that it had acquired the Saucony distribution and wholesale business. The payment will be a mixture of cash and shares and the acquisition is earnings per share accretive.
Even at the current price, the stock is yielding 5%, fully franked. The company has forecast EPS growth of 10%-15% for the current financial year. I like this company because I think it is not particularly vulnerable to internet retailers. Personally, I like to try shoes on (although reasonable minds may disagree with me).
3. Integrated Research (ASX: IRI)
Integrated Research managed to grow its consulting business in FY 2013, making up for less impressive results in Unified Communications (a VOIP service) and the sale of Prognosis. Prognosis is possibly the world's best performance management software suite, and that superiority gives the company a competitive advantage.
At the current price of $1.06 Integrated Research has a trailing dividend yield of 4.7%, partially franked. With the lower Australian dollar, I'm of the belief that Integrated will be able to grow its dividend in the coming financial year.
Foolish takeaway
Investors should be wary of blindly assessing companies based on their dividend yields. However, these three companies all have reasonable growth prospects and, importantly, are high quality businesses. All the companies mentioned in this article, including G8 Education, deserve a spot on your watchlist.
