Photo by Nicholas Cappello on Unsplash
 

Most investors focus on large-cap stocks, which are in general well-known, established companies, and thus they are considered lower-risk companies than small-cap stocks. However, small-cap stocks have historically outperformed large-cap stocks, as they have much more room for growth. Therefore, investors should not dismiss small-cap stocks. In this article, we will discuss the prospects of three small-cap stocks that are offering generous dividends and are attractive right now, namely Northwest Bancshares (NWBI), Ethan Allen Interiors (ETD), and Community Trust Bancorp (CTBI).
 

Northwest Bancshares

Northwest Bancshares was founded in 1896 in Bradford, Pennsylvania. It is a bank holding company that has full-service financial institutions providing a complete line of personal and business banking products, including employee benefits and investment management services. Northwest Bank is the leading subsidiary of Northwest Bancshares. It operates 162 branches in central and western Pennsylvania, western New York, eastern Ohio, and Indiana.

Northwest Bancshares has proved somewhat vulnerable to recessions but it has recovered from them without any problem, in contrast to some banks which caused devastating losses to their shareholders in the Great Recession. During the Great Recession, Northwest Bancshares incurred a 32% decrease in its earnings per share but continued raising its dividend and fully recovered in 2010.

In 2020, Northwest Bancshares incurred a 40% decrease in its earnings per share due to the coronavirus crisis but it kept raising its dividend. In addition, the company has fully recovered from the pandemic. The bank has an excellent debt-to-equity ratio of 0.3, which is the key to the ability of the company to withstand recessions.

Just like most banks, Northwest Bancshares currently enjoys a strong tailwind, namely the favorable environment of rising interest rates. Higher interest rates greatly expand the net interest margin of banks, i.e., the difference between the interest charged on loans minus the interest paid on deposits. In the fourth quarter, Northwest Bancshares grew its net interest income by 15% over the prior year’s quarter.

On the other hand, Northwest Bancshares posted a 13% decrease in its earnings per share in 2022, primarily due to high provisions for loan losses. Given the economic slowdown caused by the aggressive interest rate hikes implemented by the Fed, provisions for loan losses are not likely to improve significantly in the short run. As a result, we expect the benefit from high net interest income to result in just a 4% increase in earnings per share this year.

Northwest Bancshares has raised its dividend for 12 consecutive years. Due to lackluster business momentum, the stock is currently trading at a 10-year low price-to-earnings ratio of 10.6 and is offering a 10-year high dividend yield of 6.9%. Northwest Bancshares has a payout ratio of 73%, which is somewhat high, but the dividend is likely to remain safe thanks to the defensive business model of the company. Overall, the stock is highly attractive for patient investors, who can wait for the economy to recover from its latest slowdown.
 

Ethan Allen Interiors

Ethan Allen Interiors is a vertically integrated interior design company that manufactures and sells retail home furnishings, such as beds, dressers, chairs, lighting, mattresses, and decorative pieces. The company sells its products online and through its network of 302 design centers, of which 161 are independently owned and 141 are company operated. In 2022, 16% of net sales came from the wholesale segment, which includes sales from independently owned stores, while the retail segment generated 84% of sales.

As Ethan Allen sells consumer durables, its products tend to last for a long time and hence many people may forego purchasing these products during a recession. Indeed, the company has proved vulnerable to recessions. Ethan Allen suffered during the pandemic, as it was forced to shut down its service centers, but it recovered swiftly thanks to pent-up demand amid huge fiscal stimulus packages. Ethan Allen is ideally positioned to continue to benefit from the work-from-home trend, which has persisted longer than initially expected. Moreover, the company follows a build-to-order business model and thus it is the preferred choice for several customers.

Ethan Allen has exhibited a somewhat volatile performance record but it has grown its earnings per share at a 12.9% average annual rate over the last nine years. This is undoubtedly an impressive growth rate, though the company is likely to decelerate in the upcoming years due to the high comparison base formed last year amid a strong recovery from the pandemic.

Ethan Allen has raised its dividend for only 3 consecutive years, as it temporarily suspended its dividend in 2020 due to the pandemic. Due to the exceptionally high earnings expected this year, the stock is trading at a nearly 10-year low price-to-earnings ratio of 7.6 and is offering a 10-year high dividend yield of 4.8%. Ethan Allen has a solid payout ratio of 37% and a rock-solid balance sheet, with negligible payments of interest expense. As a result, the dividend of the stock has a wide margin of safety.
 

Community Trust Bancorp

Community Trust Bancorp is a regional bank with 84 branch locations in 35 counties in Kentucky, Tennessee, and West Virginia. It is the second-largest bank holding company in Kentucky, with a $5.5 billion balance sheet. The bank has raised its dividend for 42 consecutive years but it is not included in the group of Dividend Aristocrats due to its small market capitalization.

Community Trust Bancorp is an exceptionally well-managed bank, with a conservative business model. Thanks to its disciplined management, the bank has proved extremely resilient to recessions. In the Great Recession, while most banks incurred excessive losses, Community Trust Bancorp continued thriving and raising its dividend. The bank proved resilient to the coronavirus crisis as well. It incurred just an 8% decrease in its earnings per share in 2020 and recovered swiftly in 2021, with record earnings per share.

The stock of Community Trust Bancorp has plunged 20% this year due to the sell-off of the entire financial sector, particularly the group of regional banks, after the bankruptcy of Silicon Valley Bank. Thanks to its rock-solid business model, Community Trust Bancorp is likely to endure the ongoing downturn without any problem. This means that the broad sell-off of the financial sector has presented a rare opportunity to purchase Community Trust Bancorp at an extremely cheap price.

Community Trust Bancorp is trading at a 10-year low price-to-earnings ratio of 8.2, which is much lower than the 10-year average of 12.4 of the stock. Moreover, the stock is offering a 10-year high dividend yield of 4.7%. Thanks to its extremely cheap valuation level, Community Trust Bancorp is likely to offer excessive returns to investors whenever the ongoing financial turmoil subsides.
 

Final Thoughts

As some small-cap stocks have the potential to offer outsized returns, investors should not limit their scope to large-cap stocks. The above three stocks are currently trading at nearly 10-year low valuation levels and are offering 10-year high dividend yields, with a material margin of safety. As a result, they are likely to highly reward patient investors in the upcoming years.

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