The Safety Net: A 9% Yield For The Next 15 Years?

Start up concept with sketch on concrete wall and businessman

Small cap dividend payers are not widely followed. So it can be exciting to discover a 9% yield on a stock no one has heard of.

For that reason, let’s shed a little light on Compass Diversified Holdings (NYSE: CODI). It’s a private equity firm that sports a 9% yield, but has a market cap of less than $900 million and trades only 100,000 shares a day.

Its portfolio currently includes positions in nine companies, including Sterno Products – a maker of portable food-heating products – Advanced Circuits – a circuit board manufacturer – and Arnold Magnetic Technologies – a maker of magnetic equipment.

And as I mentioned, the stock pays a rich 9% yield. It has paid shareholders a quarterly dividend of $0.36 per share since 2011 and has raised the dividend four times since 2006 – even in the throes of the 2008 financial crisis, which is impressive.

But can it keep it up?

Unpredictable Cash Flow

Compass is in an interesting situation. During the first quarter, the company did not generate enough cash flow to pay the dividend. It generated $13.6 million in cash flow while paying out $19.5 million in dividends.

Last year, it covered $78.2 million in dividend payments with $82.4 million in cash flow. But in 2014, cash flow fell $14 million short of the dividend.

It’s important to keep in mind that Compass doesn’t generate cash flow like other companies do – selling more widgets or services, improving margins and keeping costs low. Instead, it invests in a portfolio of companies, which means that buying and selling opportunities can cause erratic cash flow.

For example, if Compass sells a company that generates $5 million in annual cash flow, it loses that $5 million contribution. But if it sells the company for $40 million, it now has an extra $40 million to help pay the dividend.

So it’s difficult to measure a company like Compass using traditional metrics like cash flow.

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