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The combination of a high dividend yield and a monthly dividend render Chesswood Group (CHWWF) appealing to income-oriented investors. In addition, the stock has offered an average annual total return in excess of 10% since it went public via capital gains and generous dividends. In this article, we will discuss the prospects of Chesswood Group.

Business Overview

Chesswood Group is a financial services company that operates primarily in the specialty finance industry. The company offers micro and small-ticket commercial equipment financing to small and medium-sized businesses through a network of equipment finance broker firms and equipment vendors in the U.S. It also offers commercial equipment financing to small and medium businesses through a network of equipment finance broker firms in Canada.

In addition, Chesswood Group provides home improvement and other consumer financing solutions. The company was formerly known as Chesswood Income Fund and changed its name to Chesswood Group in January 2011. Chesswood Group was founded in 1982 and is headquartered in Toronto, Canada.

The primary business divisions of Chesswood Group are its subsidiaries Pawnee and Tandem, which currently generate 55% of the company’s total revenue. Tandem sources micro and small-ticket commercial equipment originations to small and medium-sized businesses through the equipment vendor channel in the U.S.

Pawnee finances micro and small-ticket commercial equipment for small and medium-sized businesses in the U.S. It was founded in Colorado in 1982 and is focused on providing equipment financing (generally up to $350,000) to small and medium-sized businesses in the U.S., with wide range of credit profiles, from start-up entrepreneurs to more established businesses, through a network of hundreds of equipment finance broker firms.

Overall, Chesswood Group operates in niche markets and has managed to offer an average annual total return in excess of 10% to its shareholders since it went public. The strong performance has resulted primarily from the focus of management on a disciplined underwriting policy, which mitigates the risk of loans to a great extent. Another key factor behind the successful business execution is the well-trained network of reputable broker firms of Chesswood Group.

On the other hand, investors should be aware that Chesswood Group is vulnerable to recessions due to the nature of its business. During adverse economic periods, many individuals and companies struggle to service their loans, thus exerting pressure on the results of Chesswood Group.

The sensitivity of Chesswood Group to recessions was evident in 2020, which was marked by the fierce recession caused by the coronavirus crisis. Due to the impact of that recession on individual borrowers and companies, Chesswood Group switched from earnings per share of $0.55 in 2019 to a loss per share of -$0.38 in 2020.

On the bright side, thanks to the massive distribution of vaccines, the pandemic has subsided, and the economy has recovered from this crisis. As a result, Chesswood Group currently enjoys a strong recovery from the pandemic. Thanks to a significant improvement in the financial shape of its borrowers, the company reversed a great amount of loan loss provisions in 2021, and thus it posted 10-year high earnings per share of $1.26 in that year. It also posted earnings per share of $1.09 in 2022, its second-best performance in the last decade.

Growth Prospects

Chesswood Group tries to grow its earnings by expanding its network of brokers and by initiating new loans. It also tries to expand its customer base to borrowers with higher credit scores. However, this strategy is easier said than done, as it results in much more intense competition from traditional financial institutions.

Moreover, Chesswood Group has exhibited a somewhat volatile performance record over the last decade. During this period, the company has grown its average earnings per share by only 2.9% per year. The lackluster growth record has been caused primarily by the depreciation of the Canadian dollar vs. the USD.

It is also important to realize that Chesswood Group distributes a significant portion of its earnings to its shareholders in the form of dividends. This strategy somewhat mitigates the growth potential of the company. Overall, we expect Chesswood Group to grow its earnings per share by about 3.0% per year on average over the next five years, in line with its historical growth rate.

Dividend & Valuation Analysis

Chesswood Group is currently offering an exceptionally high dividend yield of 6.6%, which is more than quadruple the 1.6% yield of the S&P 500. The stock is thus an interesting candidate for income-oriented investors but U.S. investors should be aware that the dividend they receive is affected by the prevailing exchange rate between the Canadian dollar and the USD.

Chesswood Group has a payout ratio of 40%, which is healthy. Therefore, the company’s dividend seems to have a wide margin of safety in the absence of a severe recession. It is also worth noting that Chesswood Group has raised its dividend by 25% this year.

On the other hand, Chesswood Group has reduced its annual dividend by 35% over the last decade, from $0.68 to $0.44. A great part of this reduction has been caused by the depreciation of the Canadian dollar vs. the USD; hence, the company is not responsible for this. Nevertheless, it is prudent for U.S. investors not to expect meaningful dividend growth going forward.

In reference to the valuation, Chesswood Group is currently trading for 6.1 times its earnings per share in the last 12 months. Given the decent performance record of the company but also its sensitivity to recessions, we assume a fair price-to-earnings ratio of 8.0 for the stock. Therefore, the current earnings multiple is lower than our assumed fair price-to-earnings ratio. If the stock trades at its fair valuation level in five years, it will enjoy a 5.4% annualized gain in its returns.

Taking into account the 3.0% growth of earnings per share, the 6.6% dividend yield, and a 5.4% annualized expansion of valuation level, Chesswood Group could offer a 13.0% average annual total return over the next five years. This is an attractive expected total return; hence, investors should consider purchasing the stock around its current price.

Final Thoughts

Chesswood Group operates primarily in niche financial markets and is characterized by prudent management. In addition, the stock is offering an exceptionally high dividend yield of 6.6%, with a healthy payout ratio of 40%. Moreover, the stock is cheaply valued right now, and hence it can offer a double-digit average annual total return over the next five years.

On the other hand, investors should be aware of the sensitivity of the company to the underlying economic conditions and its high vulnerability to recessions. Therefore, only patient investors, who can endure extended periods of volatile business performance and remain focused in the long run, should consider purchasing this stock.

Moreover, Chesswood Group is characterized by extremely low trading volume. This means that it may be hard to establish or sell a large position in this stock.

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