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Most investors use the S&P 500 as a benchmark for the U.S. stock market but this is not the only index. The Russell 2000 index is the best-known benchmark in the world for small-cap U.S. stocks. Small-cap stocks have historically outperformed their large-cap counterparts, as the former have a great advantage; they have much more room for growth. In this article, we will discuss the prospects of three small-cap stocks that currently offer high dividend yields, namely Community Trust Bancorp (CTBI), Brandywine Realty Trust (BDN), and Office Properties Income Trust (OPI).
 

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 $5.5 billion of assets. The company has raised its dividend for 42 consecutive years but it is not included in the group of Dividend Aristocrats, as it does not belong to the S&P 500 index due to its small market cap.

The primary competitive advantage of Community Trust Bancorp is its prudent and disciplined management. Due to its conservative business model, the bank grows at a slower pace than other banks during boom times but it is much more resilient during recessions. During the Great Recession, Community Trust Bancorp remained highly profitable and kept raising its dividend.

Community Trust Bancorp proved resilient throughout the coronavirus crisis as well. Thanks to its conservative loan portfolio, the bank incurred just an 8% decrease in its earnings per share in 2020. It thus outperformed most other banks in that year. It is also remarkable that Community Trust Bancorp has posted average net loan charge-offs of only 0.03% in the last four quarters.

Thanks to the recent sell-off of the entire financial sector, the stock is currently offering a nearly 10-year high dividend yield of 4.4%. The massive sell-off of the financial sector has been caused by the collapse of Silicon Valley Bank, which incurred immense cash withdrawals from its depositors after it reported losses of $1.8 billion in its bond portfolio. However, most of its depositors were venture capitalists and technology startups, who panicked on the announcement of losses. Community Trust Bancorp has one of the most conservative business models in the entire financial sector and hence it will not face a bank run. Thanks to its solid payout ratio of 39% and its resilient business model, the bank is likely to continue raising its dividend for many more years.
 

Brandywine Realty Trust

Brandywine Realty Trust is a REIT that owns, develops, leases, and manages an urban town center and transit-oriented portfolio that includes 163 properties in Philadelphia, Austin, and Washington, D.C. The REIT generates 74% of its operating income in Philadelphia, 22% of its operating income in Austin, and the remaining 4% in Washington, D.C.

As Brandywine generates a vast portion of its operating income in Philadelphia and Austin, it greatly benefits from the advantages of these two areas. According to official reports, Philadelphia has had the highest growth rate of highly educated citizens since 2008 while Austin is the fastest-growing metropolitan area, the best place to start a business and it has retrieved all the jobs lost due to the pandemic.

The stock of Brandywine has plunged 65% over the last 12 months, to a 10-year low, primarily due to the impact of sky-high inflation on the results of the REIT and its valuation. Due to the surge of inflation, the Fed is raising interest rates at an unprecedented rate in order to cool the economy and thus restore inflation to its target level. High-interest rates significantly increase the interest expense of Brandywine and thus pressure its results. In addition, high inflation has compressed the valuation of the stock, as it has greatly reduced the present value of future cash flows.

Due to high inflation, Brandywine is currently trading at an extremely low price-to-FFO ratio of 4.1, which is a 10-year low for the stock. Brandywine is also offering an all-time high dividend yield of 16.1%, with a payout ratio of 66%. Thanks to its aggressive response, the Fed is likely to restore inflation to its normal range in the next few years. When that happens, Brandywine is likely to revert toward its 10-year average price-to-FFO ratio of 10.7. It is thus evident that the stock will have great upside potential whenever inflation subsides. Moreover, even if Brandywine cuts its dividend by 50%, it will still be offering an above-average yield. We do not expect the REIT to cut its dividend by more than 50%, given its reasonable payout ratio of 66%.
 

Office Properties Income Trust

Office Properties Income Trust is a REIT that currently owns more than 160 buildings, which are primarily leased to single tenants with high credit quality. The portfolio of the REIT currently has a 90.6% occupancy rate and an average building age of 17 years.

Office Properties is currently facing a downturn due to the work-from-home trend, which has resulted from the coronavirus crisis. While the pandemic has subsided, the work-from-home trend has proved much more persistent than initially expected.

Even worse, the REIT has been caught with a high debt load in this downturn. As a result, it is selling assets in order to reduce its debt load. Office Properties sold $260 million of assets in 2021 and $210 million of assets in 2022. Moreover, the trust is facing a strong headwind from the high-interest expense, which has resulted from the aggressive interest rate hikes implemented by the Fed.

Due to all these negative factors, the stock of Office Properties has slumped 49% over the last 12 months, to a new 10-year low. It is thus trading at a 10-year low price-to-FFO ratio of 2.8, an extremely cheap level. Moreover, the stock is offering an all-time high dividend yield of 17.5%, with a healthy payout ratio of 49%. Due to the high debt load of the REIT, its dividend is not safe. However, even if the trust cuts its dividend by 50%, it will still be offering an exceptionally high yield.

Moreover, despite the perfect storm facing Office Properties, we believe that the worse is behind the company. Given the exceptionally cheap valuation of the stock, we expect the REIT to highly reward patient investors in the upcoming years.
 

Final Thoughts

The above three stocks are small-cap stocks that offer high dividend yields. Among these three stocks, Community Trust Bancorp is the most attractive, as it is likely to offer attractive returns with minimum risk. Brandywine and Office Properties may offer a higher return than Community Trust Bancorp but they are much more vulnerable to the highly inflationary environment prevailing right now. As a result, they are suitable only for patient investors who can endure high stock price volatility.

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