Wednesday, February 16, 2011

Dividend Machines small cap versus large cap

Should income investors buy large cap or small cap companies or both? Income investors need income from many sources including buying stock in a company. Dividend machines are income investments that are publicly traded companies. We know the companies that we call dividend machines should earn more than they pay out in income and we know they should be solid companies. The question at hand for income investors is should we buy only large cap stocks or can we also buy small cap stocks to create income for the portion of our portfolios dedicated to creating income?

Large cap companies are more liquid income investments than are small cap companies. Small caps have fewer owners than large caps. Fewer shares are available to trade and that can make finding a good price difficult. Often times these companies have large positions held by insiders. With fewer shares available to trade, it is more difficult to find competition for the shares on both the buy and sell side. This means when you want to buy, it is hard to get a bargain and when you want to sell, you may not be able to find a buyer.

When key leaders leave or die, the effect on small cap companies is greater than the effect on big cap companies. Negative events that effect revenue, earnings and eventually income for the investor can affect small and large cap companies alike. Just because a company is large does not mean it can absorb negative events. Look at BP!

With all that in mind, often times small cap companies are more focused on maximizing shareholder income than large cap companies and this is good for income investors. It is really a wonder of capitalism that someone else creates a company and is willing to share income with us income investors.

As you know, I have profiled several small cap companies as income investments. Those that qualify to be included in our dividend machines have shown an ability to increase earnings over time and to increase dividend income over time. Most have been around over 20 years. All are solid companies. When I invest for income in a dividend machine, I am not looking to sell it anytime soon. I want to get the benefit of a big dividend that increases every year. That means I am not afraid of the liquidity issues of small cap companies.

All investing carries risk and this is especially true of investments in the stock of companies. However, income investors have few choices and right now bonds are still too expensive to buy so we are left with solid, dividend producing companies that increase our income every year.

The answer to the conundrum is to invest for income in both large cap and small cap companies. Do your research and make sure your income investments are in good companies, big or small.

Very Truly Yours,

TheMoneyMadam