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11.2% dividend yield? A small-cap stock to buy in an ISA right now

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When hunting for high dividend yields, seeing something in or close to the double-digit range is often a sign to steer clear. Yet a massive and sustainable income opportunity may exist in the case of Somero Enterprises (LSE:SOM).

As a quick reminder, the company is a designer and manufacturer of laser-guided screed machines. These are essential to the concrete-laying process in many construction projects.

At its current share price, the engineering group boasts a market capitalisation of £211m. That’s small-cap territory, which explains the stock’s volatility. Yet the company has quite an extensive record of delivering impressive passive income to its shareholders. And could be an excellent income stock to buy today.

Investigating the 11.2% dividend yield

Despite being listed on the London Stock Exchange, Somero’s operations are mainly in the US. As such, the company reports its results in US dollars and pays dividends in that currency as well.

Looking at current exchange rates, this is working in shareholder favour and is undoubtedly contributing to today’s impressive double-digit dividend yield. Unfortunately, volatility in foreign currencies can potentially reverse this advantage into a disadvantage in the future.

Looking at Somero’s full-year results for 2021, a total of $0.5072 per share was returned to shareholders. At today’s exchange rate, that’s worth roughly 43p. But this overall figure is somewhat misleading if taken at face value.

Around 26p is a standard dividend payment. The remaining 17p originates from a supplemental payout. The latter is effectively a special dividend that’s repeatable under certain conditions. In the case of Somero, management has a policy to return 50% of excess net cash to investors.

This payment structure opens the door to payout volatility. And it explains the large fluctuations in dividends per share over the last five years, even when ignoring the height of the pandemic.

Excluding the supplemental portion, Somero’s dividend yield stands at 6.8%. That’s quite a reduction. But it’s still impressive and certainly sounds less like an income trap.

To buy or not to buy?

Making and selling concrete laying machines is hardly the most exciting business model. Yet, it serves a critical role in building and maintaining infrastructure. And given the US government has signed a $1trn infrastructure investment bill, Somero undoubtedly has plenty of growth opportunities to capitalise on.

That certainly bodes well for income-seeking investors. And in its latest interim results, management had already raised shareholder payouts by 11% this year. However, the final supplemental dividend per share remains a mystery.

For 2022, the company has defined excess net cash as anything above $25m. And at the end of June, net cash stood at just $27.2m. That’s significantly lower than the $32.8m balance a year ago. Therefore, unless excess net cash surges in the year’s second half, the total shareholder payout could be lower than in 2021.

The end result is likely the dividend yield being dragged down, despite no payout cut technically happening. But if investors have their expectations in the wrong place, a decline in total dividends could induce substantial short-term volatility. And that’s a risk that needs to be considered before committing to any investment.

Nevertheless, given the group’s excellent operational track record, paired with substantial long-term growth opportunities, Somero Enterprises looks like an excellent income stock for investors to buy and hold in an ISA today.

The post 11.2% dividend yield? A small-cap stock to buy in an ISA right now appeared first on The Motley Fool UK.

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Zaven Boyrazian has positions in Somero Enterprises, Inc. The Motley Fool UK has recommended Somero Enterprises, Inc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.