For much of my career managing equity income funds the majority of smaller companies have had little interest in paying significant dividends to shareholders. 
Most have focused on reinvesting and growing their business as a key priority. Income funds have therefore relied for many years on a small number of large companies to do the heavy dividend lifting for them.
This long-term trend has now seen better days with giants such as Tesco and Glencore slashing their dividends and others such as BP, Glaxo and Vodafone struggling to support increasingly onerous dividend commitments.
Things are now beginning to turn full circle with an increasing number of smaller companies recognising the importance of offering investors a high and growing income whilst continuing to invest for the future.
When we assess dividend cover for the UK market there has been a sharp decline in the past two years. This is a function of deteriorating cover levels amongst the largest companies as earnings fall and increasing dividend pay-out ratios across the wider market.
We believe that the dividend prospects for medium and smaller companies now appear far brighter, reflecting the generally higher exposure that such businesses have to a recovering UK economy.
When we launched the Saracen UK Income fund recently a lot of our research efforts went into discovering smaller companies which offered secure and growing dividend payments over the longer term funded by sound balance sheets.
Some are older businesses which are undergoing strategic change, others newer entrants to the public markets.
One sector in particular where we have uncovered interesting stock ideas is the technology sector. Historically this has been an area of thin pickings for income investors but the Fund now has meaningful positions in three growing companies where the dividend potential is positive.
Kainos is an IT services, consulting and software business with around 75 per cent of its revenues coming from the UK public sector. The business came to the market as an IPO this July and, whilst it is early days, we believe they have exciting prospects.
Performance of stock vs index since listing
Source: FE Analytics
Their customers typically have high IT budgets and multi-year projects to manage. Key clients include DVLC, the Cabinet Office and a number of NHS Trusts.
Kainos is benefitting from the digitalisation of public sector functions and a move away from large-scale IT procurement contracts towards smaller, more manageable suppliers. This is driven by the need to significantly reduce costs to the taxpayer and avoid the historic tendency towards huge cost overruns.
We believe that this process is still at a very early stage and Kainos has many years of strong growth ahead of it. This is supported by net cash on the balance sheet which should allow positive dividend progression. Despite a strong rise in the share price since IPO we forecast a dividend yield of just under 3 per cent.
FDM Group is an IT services provider supplying entry level staff to help clients operate business as usual functions. The company was listed in July 2014 and has recently delivered positive interim results, with revenues up 35 per cent.
The business model revolves around selecting and training high calibre graduate recruits seeking a route into a career in IT and business management. Financial services are a key sector for FDM and major clients include Barclays, UBS and HSBC.
Performance of stock vs index since listing
Source: FE Analytics
From a strong foundation in the UK FDM has now moved further afield, following their key global clients into new countries and has significant growth prospects in Europe, Asia and North America.
The company has £15m net cash and the dividend prospects are excellent with positive cash conversion and low capital spend being a feature. FDM offers investors a healthy starting yield of over 3 per cent with prospects of double-digit growth from here.
Special dividends may also be possible within a few years with growth expected to be largely organic. Whilst the shares’ potential has begun to be recognised we can see many years of good performance ahead
By contrast Laird has had a chequered past with the dramatic decline of its biggest customer Nokia in 2009 leading to collapsing profits, a rights issue and dividend cut.
Performance of stock vs index over 10yrs
Source: FE Analytics
However in recent years new management has energised and refocussed the business to become a trusted technology partner to customers such as Apple, Samsung and the Big 3 US auto companies.
There are two main businesses: performance materials include shielding, thermal and noise management products for mobile, gaming, wireless & IT networks; wireless systems supplies telematics and antennae for the auto industry as well as wireless components for industrial and medical equipment.
Laird stands to benefit from the surge in use of its products in the ‘connected world’, as its customers increasingly use wireless and mobile technology for connectivity. Recent results confirmed that the turnaround in Laird continues and it offers a solid 4 per cent dividend yield as well as improving long-term prospects.
Scott McKenzie is manager on the Saracen UK Income fund. The views expressed above are his own and should not be taken as investment advice. All three stocks discussed are core holdings in the Saracen UK Income fund.
