Is there a way to grab outstanding profit potential and generate income at the same time? As always, it depends where you look.

Here at Notes we spend the best part of the day combing the little-known world of contrarian investing for money-making ideas the mainstream has overlooked.

We call it the underground, because the kind of market intelligence we dig up can’t be found in the mainstream press. And many of the ideas that circulate in this hidden world actually take advantage of mainstream manias and hysterias to bag big profits.

Small-cap expert Marc Lichtenfeld at The Smart Profits Report says the secret to this profit-income combo is to look for that rare flower: small-cap stocks that pay solid dividends. Now, most investors don’t look to small-caps for income potential. But although most small-caps recycle profits back into the company growth, a number of small-caps do pay dividends…

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.

Readers should take note that the Nasdaq and Russell (small-cap indexes) have risen 58% and 67% from their lows. So it makes sense to take a more defensive position in small-caps right now. Marc has taken the pain out of choosing the right growth-income balance stocks with three rock-solid picks in this sector…

1. 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%

2. 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%

3. 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%.