One of the bigger risks in the markets is index risk. This is because the market for stocks continues to consolidate into fewer and fewer shares of listed companies. It hit a peak in the 1990s at around 8,000 stocks in the U.S. market, but that number now is less than 4,000 individual listed stocks. Less opportunity and more concentration of risk.
That risk shows up in the greater number of index-tracking exchange-traded funds (ETFs) that now number near 1,800 in the U.S. market and over 5,000 globally. And those index tracking ETFs concentrate trading in more and more of the well-followed and index-linked stocks.
The impact is that if one stock — say, Apple Inc. (NASDAQ:AAPL) — has a bad day, it can drive indexes such as the S&P 500 or Dow Jones Industrials down significantly. And along with it many ETFs that are sitting in many individual investors’ portfolios.
The antidote is to diversify into smaller stocks that aren’t found in many indexes or ETFs to insulate your portfolio from general market sell-offs led by indexes.
Here are three smaller stocks that not only have the benefit of being small — they are also great dividend payers.
I’ll start with Natural Resource Partners LP (NYSE:NRP). Natural Resource owns large parcels of land in the Eastern U.S., Appalachia, Central Illinois and the Western U.S. And in turn, it leases the land to mining companies under long-term contracts in return for royalty payments. It is set up as a passthrough, which means that investors get the majority of the net profits passed through without the company paying corporate income taxes.
And the dividends are also partially shielded from current income tax for shareholders as well.
Revenues are steady and expenses to maintain the contracts are low making for fat operating margins sitting at 43%. And the payout is nice with quarterly dividends of 45 cents, providing a yield of 5.7%.
Next is an asset management company that, while it runs billions of dollars in its funds, is actually a smaller company. AllianceBerstein Holding LP (NYSE:AB) is another passthrough that gathers and manages assets and in turn passes though the majority of its profits to its shareholders, again without paying corporate taxes. As an asset manager, it’s not as much about the performance as it is just keeping the assets in the funds and earning management fees.
Revenues from fee income has been steadily climbing. This is resulting in a nice stream of dividend distributions for shareholders, with the next payout set for 73 cents. This provides a nice dividend yield of 11%.
And last in this small group of stocks is MFA Financial (NYSE:MFA). MFA is a mortgage investment company that’s structured as a real estate investment trust (REIT). As a REIT, it also pays out the majority of its profits to shareholders while avoiding corporate income tax. And shareholders also get the benefit of being able to deduct 20% of the dividend payout from their taxable dividend income.
MFA has a great track record of acquiring and managing mortgage securities. You can see it in how during the mortgage finance troubles in the U.S. market from 2007 to 2008, the company managed to remain profitable.
The dividend stream has been very steady, with a quarterly payout of 20 cents providing a yield of 10.6%.
Neil George is the editor for Profitable Investing and does not have any current holdings in the securities mentioned above.