A dividend-led investing strategy has merits, so what could be better than searching for a big dividend among small-cap shares? That way, we can collect decent income while embracing the growth potential that many smaller firms offer. After all, to latch on to one of the stock market’s really big winners, we really need to get on board smaller firms with plenty of room to grow.
The theory is attractive but, in reality, I reckon dividend-hunting investors tend to be more conservative than small-cap investors. Indeed, small-cap firms can present us with extreme volatility, and their shares can move much faster than large-cap stocks. I think the two strategies of income investing and small-cap investing probably don’t sit comfortably together for many!
Volatility assured
One wild ride for investors has been provided by gold miner Pan African Resources (LSE: PAF), which has operations in South Africa. Indeed, the share price was as low as 7p in 2015 when I last wrote about the company, but it had shot up to around 22p by the summer of 2016 and is now back down at just above 10p.
However, the volatility is not just because of the company’s small-cap status. All mining companies have been volatile over the period and I think the big swings in operations and share prices tell us more about their cyclical nature than anything else. A great deal of the trading outcome is outside the control of mining companies, which tend to see their fortunes ebb and flow according to the prevailing price of the commodities they deal in which, in turn, is affected by macroeconomic conditions.
I see all mining firms as inherently risky for investors. Right now, Pan African Resources sports some tasty-looking valuation indicators, such as a price-to-earnings ratio of just over six for the trading year to June 2019 and a forward-looking dividend yield upwards of 4%. But I reckon its cyclicality means the firm doesn’t deserve a higher rating. Who knows what the price of gold will do from here? In some ways, I see investing in commodity firms like this as more like gambling than investing.
Trading well – for now
Yet, the half-year report out today is upbeat. Chief executive Cobus Loots explained in the narrative that the firm enjoyed a “robust” operational, financial and safety performance in the period and is “positioned” as a low-cost and long-life gold producer. One negative, as I see it, is that net debt rose more than 160% to £103m, due to the construction of the firm’s Elikhulu tailings retreatment facility. Companies do need to invest to grow, but if there’s a downturn in demand, or if commodity prices plunge, the firm’s borrowings could become problematic.
Looking forward, the directors said there is an “attractive” pipeline of near- to medium-term growth projects. I think, though, it’s a case of you pay your money and you take your punt with small-cap mining shares. The stock could shoot up again from here, but I don’t believe there’s any reliable way to predict the possibility of that happening with analysis – fluctuating commodity prices could change everything. I certainly wouldn’t lead an investment decision on Pan African Resources with the level of the dividend!