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.

[ad#Google Adsense 336×280-IA]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.

On Compass’ first quarter conference call, CEO Alan Offenberg was asked how long the company could continue to pay the dividend in light of cash flow fluctuations.

He explained that sales and acquisitions will have an effect on cash flow, but he believes the company will be able to sustain the current dividend for at least 15 years.

A Solid History

SafetyNet Pro – our proprietary dividend rating system – can’t rate Compass, due to a lack of analyst estimates, which factor into the system’s rating formula, but I will give it a shot.

The company has an excellent track record of paying dividends, with no cuts in the 10 years since it began paying one. Cash flow just barely covered the dividend in 2015, and while we’re not off to a good start in the first quarter of 2016, one quarter doesn’t make the year.

I’ll also consider the CEO’s confidence in the dividend, but only to a certain extent. I don’t take any company’s management at its word. Many CEOs have claimed their dividends were safe right before they cut them. That being said, it’s certainly better to hear a CEO express confidence in the dividend than to hear him avoid the question.

In this case, the CEO’s statement puts his integrity on the line.

If he cuts the dividend in the future, investors will be furious because he led them to believe it would remain safe.

That could lead to him losing his job.

Given the company’s track record and CEO’s statement, I’m going to give the company the benefit of the doubt.

The dividend is fairly safe.

If Compass fails to deliver enough cash flow to pay the dividend this year, I’ll likely revisit the rating next year.

Dividend Safety Rating: B

— Marc Lichtenfeld


Source: Wealthy Retirement