Small-cap outperformance is persisting - and these 15 quality stocks pay rich dividends

By Mark Hulbert

Think large caps are still the best bet? The data say you are looking in the wrong place.

U.S. small-cap stocks have beaten the largest stocks for over a year.

Look for small-cap U.S. stocks to continue beating the largest stocks.

That's because small-cap relative strength trends tend to persist, and U.S. small-cap stocks have beaten the largest caps for over a year. Over the past 12 months (through July 10), the Russell 2000 index RUT, which represents small- and midcap stocks, produced a total return of 20.7%, versus 11.3% for the large-cap-dominated S&P 500 SPX.

The trend-following tendency of small-cap relative strength is consistent with my analysis of small- and large-cap returns over the past century. Relative strength over the trailing year is the strongest predictor of whether the smallest stocks will beat the largest in a given month. Put simply, outperformance persists, and so does underperformance. No other factor that I studied, including trends in inflation, interest rates or the overall market, had any ability to forecast whether small-cap relative strength would continue.

Quality counts

If you bet on small-cap relative strength as a portfolio strategy, you should know that it's important to pay close attention to each company's balance sheet and income statement. That's because there's a huge divide in the small-cap sector between companies with solid financials and those without. Small "junk" stocks tend to perform poorly - regardless of whether small stocks overall are leading the market.

Several ETF options are available to invest in small-cap quality stocks. One example is the Invesco S&P Small Cap Quality ETF XSHQ, with a 0.29% expense ratio. Another is the iShares MSCI USA Small-Cap Quality Factor ETF SQLT, with a 0.20% expense ratio.

To invest in individual small-cap quality stocks, consider those in the table below. To construct it, I started with a list of stocks that are recommended by any of the investment newsletters that my performance-auditing firm monitors. I then eliminated any with a market cap above $5.7 billion, which is the breakpoint between the Russell 2000 and the Russell 1000 index RUI of the largest-cap companies. I next eliminated any stocks that had a beta above 1.0, a negative five-year growth rate of net income, a price-to-book ratio above the overall market, and a low dividend-payout ratio.

Each of these criteria have been used in prior studies to differentiate quality stocks from junk. The 15 small-cap stocks listed below are those that survived this winnowing process and boast the highest dividend yields.

 
Ticker                         Stock                      Market cap (in billions)   Dividend yield  
GTY                            Getty Realty               $2.1                       +5.60% 
CALM                           Cal-Maine Foods            $4.2                       +5.45% 
AVA                            Avista                     $3.5                       +4.70% 
PEBO                           Peoples Bancorp (Ohio)     $1.4                       +4.39% 
DOX                            Amdocs                     $5.6                       +4.38% 
SR                             Spire                      $4.8                       +4.09% 
NWN                            Northwest Natural Holding  $2.1                       +3.91% 
OZK                            Bank OZK                   $5.5                       +3.79% 
NWE                            NorthWestern Energy Group  $4.5                       +3.69% 
HNI                            HNI                        $2.9                       +3.50% 
MZTI                           Marzetti                   $3.1                       +3.48% 
OGS                            ONE Gas                    $5.0                       +3.44% 
FRME                           First Merchants            $2.7                       +3.43% 
BOH                            Bank of Hawaii             $3.3                       +3.39% 
WABC                           Westamerica Bancorp        $1.4                       +3.29% 
Source: LSEG, Hulbert Ratings 

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

-Mark Hulbert

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07-18-26 1022ET