Can you notch up profits and earn solid, steady income at the same time?

Usually, the two don’t go hand-in-hand – especially not in the small-cap sector.

But that doesn’t mean to say that it’s impossible to grab the best of both worlds.

If you’ve read my columns here or in our monthly Xcelerated Profits Report newsletter, you know that I focus on the small-cap space – both in my specialist areas of healthcare and biotech and other sectors, too.

Typically, these small-cap stocks are ripe for big gains more so than income through dividends. But I’m actually a big fan of dividends, too.

So what if there were a way to load your portfolio with outstanding profit potential and generate income, too? There is – and I’ve got three stocks below that can do the job…

Digging For Dividends

I’m not a market timer so I’m not going to tell you that now is the time to get out of equities before the market turns lower.

But what I will say is that with the Nasdaq and Russell 2000 (small-cap) indexes having blasted off their lows by 58% and 67% respectively, it makes sense to get a bit more defensive.

The reason is two-fold – and very simple: Owning dividend-paying stocks generates income and improves a portfolio’s return over the long-term.

However, it’s hard to find good small-cap companies that pay dividends. Smaller companies usually pour any excess cash back into the business to help it grow, rather than distributing it back to shareholders.

In fact, of more than 7,400 stocks with market caps under $1 billion, only 1,356 pay dividends. And if you want a meaningful dividend yield – let’s say 3% – the number decreases to less than 800.

I further whittled down the list to companies with high current ratios, low debt, and profit expectations to help ensure that dividends would continue to get paid.

I also stayed away from companies that paid a very high dividend. Companies with yields approaching 10% or higher may find those payouts unsustainable if business continues to be difficult.

Yes, if you want a higher potential reward, you do need to take on more risk. But buying stocks with sky-high dividends is riskier than those with solid but more sensible yields.

Here are three of the best from my small-cap dividend stock screen…

A Trio Of Small-Cap Dividend Stocks

• WD-40 Company (Nasdaq: WDFC): The company makes everyone’s favorite industrial lubricant – WD-40 – plus household cleaners and other products. Through the first nine months of its fiscal year, it generated $18 million in profits and boasts $36 million in cash versus $21 million in debt. Earnings per share are expected to grow 13% in fiscal 2010.Current dividend yield: 3.4%

• American Ecology Corporation (Nasdaq: ECOL): The firm handles America’s hazardous waste. Not a great business if you’re the guy with the rubber gloves moving barrels of the stuff. But not bad if you’re an investor – particularly a new one, given that the shares have endured a beating over the past year.ECOL is profitable, has $24 million in cash and no debt. Over the first six months of 2009, it generated $17 million in cash from operations. So far it has paid out over $6 million in the form of dividends.

  Current dividend yield: 4%

• CDI Corporation (NYSE: CDI): The company provides engineering and information technology staffing services. With so many businesses cutting jobs, it’s had a tough time over the past year. But it’s still profitable, with earnings per share expected to nearly double next year. It has $77 million in cash, no debt and generated $10 million in cash from operations.Current dividend yield 3.6%.

If you have any small-caps paying dividends in your portfolio, use the “Comments” link below to let me know which ones are your favorites and I’ll run a follow-up column, featuring stocks sent in by readers. Be sure to tell me why you like the stocks, too.

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld
Smart Profits Report