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6 Small Caps to Fund Your Retirement

The words “small cap” and “retirement portfolio” aren’t often heard in the same sentence. Stocks with smaller market capitalizations can be fantastic long-term growth investments. After all, most mega-cap stocks started out as small-cap stocks.

magnifying small capsPlus, small caps (along with value stocks) have been proven to outperform the market over time, according to Fama and French. So it makes all the sense in the world to keep small caps on your radar as an investor.

But small caps generally fail my basic tests of suitability for a retirement portfolio. As I wrote in my critique of Warren Buffett’s Berkshire Hathway (BRK.A, BRK.B), a stock to be held in a long-term retirement portfolio should have a highly predictable business model, should be “technology proof” and should pay steadily rising dividend. Most small-cap stocks will fail one — or often all — of these criteria.

But there are definitely some small-cap stocks out there that are completely appropriate for a retirement portfolio, and I’m going to offer up six of them today. With any luck, none of them will be small caps forever. Their steady growth will eventually land them in mid-cap or even large-cap territory.

Small Caps for Retirement: StoneMor Partners (STON)

stonemor-partners-lp-ston-stock-185Market Capitalization: $850 million

I’ll start with StoneMor Partners (STON). This is a stock that doesn’t make it onto too many investors’ radar screens. To start, it’s a publicly traded cemetery. That’s about the least sexy business you can run. Secondly, because it’s a small cap with a market cap of just $850 million, not too many analysts cover it. And compounding things further, it’s organized as an MLP, making it problematic to own in an IRA account.

But perhaps worst of all, cemeteries have ridiculously complex accounting and are required to defer recognition of a good chunk of their revenues until … well, until their customer dies and gets interred.

All of these factors contribute to make StoneMor something of an outcast. But I consider StoneMor a fantastic retirement stock. Its business is predictable. Until we discover the cure for old age, it’s definitely technology proof. And it happens to pay one of the highest yields currently available on the market, at 9.5%.

And the story actually gets better. Following the recent volatility in StoneMor’s stock price, company insiders have been aggressively buying the stock.

If you’re looking for great retirement-safe small caps, StoneMor is one I’d be perfectly comfortable salting away.

Small Caps for Retirement: Preferred Apartment Communities (APTS)

preferred-apartment-communities-apts-185Market Cap: $220 million

Next up is Preferred Apartment Communities (APTS), an apartment REIT with a market cap of just $220 million. With Millennials entering the workforce — yet deferring home ownership — apartments have been in a nice demographic sweet spot, and Preferred Apartment Communities has been there to reap the rewards.

APTS meets my criteria as a retirement stock. It’s business highly predictable: it owns and rents out apartment buildings. It’s also technology proof. Unless I’m missing something, a smartphone app can’t replace a roof over my head. And it definitely pays an attractive dividend. At current prices, it yields 7.2%.

And importantly, despite Preferred Apartment Communities’ short history (it went public in 2011), the REIT has consistently raised its quarterly dividend. In fact, it has done so twice in just the past year, from $0.16 to $0.175 and then to $0.18.

This certainly isn’t one of those small-cap stocks that will double your money in a year. But it looks like a steady grower that would be a nice fit in a retirement portfolio. And given its modest market cap, it would also be a price acquisition candidate.

Small Caps for Retirement: STAG Industrial (STAG)

Stag-Industrial-185Market Cap: $1.2 billion

And while we are on the theme of REITs, my next recommendation is STAG Industrial (STAG), a young REIT with a market cap of $1.2 billion. STAG has been publicly traded since 2011.

I suggested STAG in “5 High-Yield REITs for Growth and Income,” and I would reiterate that recommendation here. STAG owns a portfolio of single-tenant industrial properties (“STAG” stands for “Single Tenant Acquisition Group”) and owns things like distribution centers and warehouses.

STAG certainly meets my criteria as a retirement stock. Its business is predictable, if perhaps a little more economically cyclical than Preferred Apartment Communities. It’s also future proof, and may actually benefit from shifting technology trends. As more commerce moves online and out of brick-and-mortar stores, there will be increasing demand for warehouses and distribution centers.

And on the dividend front, STAG is a rock star. At current prices, STAG sports a juicy dividend yield of 8%, and it pays its dividend monthly.

STAG has gotten obliterated in the recent spate of volatility. But I would view this turbulence as a fantastic opportunity. Between its current dividend yield of 8% and its expected dividend growth rate of about 7% per year, and you’re looking at some serious returns just in cash alone. Add in some valuation expansion, and you’re probably looking at returns of 15% or more per year. That will double your money in about five years.

Small Caps for Retirement: Retail Opportunities Investment Corp (ROIC)

Retail Opportunity Investments ROIC 185Market Cap: $1.6 billion

And for good measure, let’s throw in one last small cap REIT, shopping center landlord, Retail Opportunities Investment Corp (ROIC).

Retail Opportunities is a relatively young REIT, having gone public in 2009. It’s also still very small with a market cap of just $1.6 billion.

This REIT has a simple enough business model: It buys neighborhood shopping centers, generally anchored by a “necessity-based” retailer such as a major grocery store. ROIC currently owns and operates 64 shopping centers encompassing approximately 7.6 million square feet.

It’s hard to get more predictable and technology-proof than a grocery store. Sure, online grocery shopping and delivery will probably reduce foot traffic to traditional grocery stores in the years ahead. But it’s hard to see the traditional grocery model being too badly disrupted any time soon.

Meanwhile, ROIC pays a decent dividend at 4.2%. This is one of those rare small caps that would make a fine addition to a retirement portfolio.

Small Caps for Retirement: Blue Knight Energy Partners (BKEP)

blue-knight-energy-partners-bkep-185Market Cap: $205 million

For a small-but-promising midstream MLP, take a look at Blue Knight Energy Partners (BKEP). Blue Knight has a market cap of just $205 million, making it the smallest of the small-cap stocks covered here. So it might be a little too small for most retirement portfolios. But it’s still one of the small caps that’s worth considering.

Blue Knight does indeed meet my criteria. As a midstream pipeline MLP, Blue Knight operates in a predictable business. Yes, the prices of oil and gas fluctuate wildly. That fact has never been more apparent than today. Yet midstream pipelines are mostly immune to falling energy prices, and Blue Knight has continued to grow its business despite the energy rout.

Blue Knight may not quite be “technology proof,” as I suppose someday we may no longer need fossil fuels. But I can credibly say that it is technology proof for at least the next decade and probably far longer.

And finally, Blue Knight pays a high and growing distribution. At current prices, Blue Knight yields 9.1%, and it raised its dividend by 7.5% last quarter. Not bad at all.

Barron’s recently wrote that there was a “big disconnect” between Blue Knight’s current stock price and it prospects. I would agree completely.

Small Caps for Retirement: Teekay Corporation (TK)

Teekay LNG PartnersMarket Cap: $2.6 billion

With a market cap of $2.6 billion, Teekay Corporation (TK) is pushing the limits of what most investors might consider a small-cap stock. But it is certainly small enough to be off the radar of many large investors. And their loss is our gain.

Teekay is a quirky little company. It’s considered a midstream MLP (or more accurately the general partner of multiple midstream MLPs), yet unlike most midstream MLPs, Teekay is not a pipeline company. Teekay is in the business of maritime oil and gas transportation, and it primarily owns tankers and offshore facilities.

Teekay is the general partner of two MLPs, Teekay Offshore Partners (TOO) and Teekay LNG Partners (TGP) and the controlling shareholder of another corporation, Teekay Tankers (TNK). I’ve been a fan of MLPs for a decade now, but I actually consider the general partners to be the better long-term investment. While the dividends or distributions might be slightly lower, the dividend growth rate tends to be much faster, as the general partner takes a disproportionate share of the income.

Teekay Corporation is currently a tanker company in its own right, but it is transitioning into a pure-play general partner by dropping its operating assets down into its MLPs. And that can only mean one thing: A big surge in dividend growth.

Teekay raised its dividend by 70% earlier this year, and management expects annual dividend growth of 15% to 20% over the next three years. Should Teekay’s stock price keep pace with its dividend growth, this stock should double your money in about three years.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. As of this writing, he was long APTS, BKEP, STAG, STON and TK. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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