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With all the recent number of new listings on the AltX the Small Cap investor's options have almost doubled. No doubt some of these listings will fail (such is the intrinsic risk of an IPO or newly formed company), but enough of these companies appear to offer real value to growth investors.

Hence all the over-subscribed private placements.

Although I will not discuss all of the new listings here, I have noticed that a number of them either have dividend policies in their offering to the market (i.e. they promise to or already do pay dividends) or already pay dividends.

Now, most of us know that dividends are tax free, thus a dividend yield on a share of 4% actually beats an interest rate on a bond of, say, 6%. This is because (excluding the interest exemption allowed by SARS), if you are paying the marginal tax rate of 40% then you will only receive 3.6% return on the interest of 6% after tax. I’ll take the 4%, thank you.

So the higher your income tax bracket, the more appealing dividends are - basic logic.

The other (hidden bonus and flaunted risk) of dividends is that the fair value of the underlying share paying them can (and probably will) fluctuate. Thus, if you pick a "dividend yielder" correctly, you make a nice capital gain. At the marginal tax rate for a natural person that means you only include 10% of the gain on the sale in your taxable income.

A double bonus for the smart investor.

So…what does this have to do with Small Caps?
Well, Small Caps often have the best potential for a growth and—taking into account the risks—can offer the best chance for capital appreciation. Their dividend yields are traditionally higher too, as they are traded at a risk premium (i.e. a lower PE ratio than Blue Chips, as their risks are higher).

Let me show a quick break down of a couple Small Caps potential "dividend yielders" I have noticed. Note that 3 out of the 5 are newly listed ones and Esor has yet to pay its first dividend at the end of the 28 February 2007:

The Dividend Yield of the All Share is approximately 2.22%, so an average Dividend Yield of 3.704% for a portfolio holding equal weightings of all five shares above would beat the market’s "safe" dividend return. Not only this, but it would expose you to the construction industry (Esor), the financial services industry (SAB&T and IFCA), the tourism industry (Gooderson), and the IT industry (ISA and IFCA)…all with companies that have potentially good growth aspects, enthusiastic management, and promising futures.
Note, the All Share also has a PE of 17.42, thus this "virtual portfolio’s" PE of 16.61 might allude to it being a value play too.

I haven't included Silverbridge Holdings Ltd ( SVB ), a niche software company that's newly listed on the AltX. But it derives more than half its income from annuities. This makes it cash-flush like ISA and it may well also pay hansom dividends in the future. Although, it does have startup risks associated with it, whereas ISA has been producing profits for a number of years now…

I also haven’t included IPSA (IPS), although once it receives its Carbon Credits and begins to produce power at its Newcastle Powerplant on 23 February 2007, its first dividend should follow within a year.

I'm definitely not advocating blindly going out and buying all the Small Cap shares that hint at dividends, but rather I am aiming to give a different spin on things for private investors interested in tax free money with Small Cap growth potential attached.

Yours,
Keith McLachlan

Keith McLachlan is an active equity investor and is the editor of the blog "Small Caps with Keith McLachlan" (www.smallcaps.co.za). This is a collection of financial/investment theory for the self-education of investors and a site dedicated to high potential Small Caps on the JSE with full length valuations and research reports.