By Serkan Unal
David Dreman is the archetype of a contrarian value investor. His multi-decade professional experience has been focused on committed value investing in pursuit of "established, structurally sound companies whose intrinsic values exceeds what the market is giving them credit for." In Kiplinger's Personal Finance Magazine in 2001, Dreman described his investment approach - buying ignored, undervalued, yet fundamentally-sound companies: "I buy stocks when they are battered. I am strict with my discipline. I always buy stocks with low price-earnings ratios, low price-to-book value ratios and higher-than-average yield." There is evidence supporting the success of his approach, as academic studies show that undervalued, out-of-favor stocks outperform the market consistently over long periods of time.
Dreman, who founded Dreman Value Management in 1977, wrote several books on contrarian investing, starting with, "Contrarian Investment Strategy: The Psychology of Stock Market Success" in 1980, "The New Contrarian Investment Strategy" in 1982, and "Contrarian Investment Strategies: The Next Generation" in 1998. He has also authored a large number of investment articles in the Journal of Investing, Financial Analysts' Journal and The Journal of Financial Behavior. Furthermore, Dreman has been a regular contributor to the Forbes magazine, writing the reputed "The Contrarian" column for more than two decades.
Dreman's record is not impeccable. His funds, which are well diversified, still tend to underperform the U.S. benchmarks during the excessive market rallies, including the Internet boom in 1999, and the 2008 global financial crisis, when his funds were overweight in financial stocks. Still, his record over the long term is generally one of success. With this in mind, here is a closer look at five dividend-paying value stocks from Dreman Value Management's portfolio.
Protective Life Corporation (PL) was the fifth-largest equity position in Dreman's portfolio in the third quarter, valued at more than $40 million. Protective Life Corporation is a $2 billion company providing life insurance, annuities and investment products. The stock is deeply undervalued relative to its industry, given its price-to-book of 0.5 versus 1.1 for its industry and the price-to-sales ratio of 0.6 versus 0.8 for the industry. With a forward P/E of 7.4, it is trading below the industry average of 7.9. The stock pays a dividend yield of 2.7%, 50 basis points above the average yield on the S&P 500. Its payout ratio is low at 18%. Over the past five years, the insurance company's EPS shrank slightly and its dividend was almost halved in 2008. However, the dividend has increased since by 50%. For the reference, the company's peers MetLife (MET) and Prudential Financial Inc. (PRU) pay dividend yields of 2.2% and 3.0%, respectively. Protective Life's stock has a high free cash flow yield of 20.2% and ROE of 7.9%. The stock is up nearly 22% over the past year. The stock is also popular with value investor Ken Fisher and AQR Capital's Cliff Asness.
Meredith Corporation (MDP) is the seventh-largest holding in Dreman's portfolio, valued at more than $38 million at the end of the third quarter. The company is a magazine publisher whose business model has been under threat due to digitalization. The stock has seen consistently high short interest as a percentage of the float. The company's top line has grown due to political advertising, while non-political revenue is under pressure due to slow economy. Over the past five years, its EPS contracted at an average rate of 7.7%, while its dividends grew, on average, by 15.6% annually. The company generates large, consistent free cash flow, which is providing for generous dividend payouts. Meredith Corporation pays a high dividend yield of 4.5% on a payout ratio of 64% of trailing earnings but only 47% of free cash flow. The company's peer Martha Stewart Living Omnimedia (MSO) does not pay any dividends, while competitors McGraw-Hill Companies (MHP) and Scholastic Corporation (SCHL) are each yielding 1.8%. Meredith Corporation is attractive value based on its high dividend yield and price-to-book of 1.9 versus 3.1 for its respective industry. The stock has a forward P/E of 12.2, below the industry ratio of 15.4. The stock is up nearly 12% over the past year. Fund managers Chuck Royce (Royce & Associates) and John Rogers (Arial Investments-check out its top picks) are also buyers of this stock.
Hospitality Properties Trust (HPT) is the 12th-biggest position in Dreman's portfolio, worth more than $37 million at the end of the third quarter. The company is a REIT buying, owning and leasing hotels. The REIT pays a monster dividend yield of 8.3% on a payout ratio of 60% of normalized funds from operations. The REIT has a price-to-book of 1.2 versus 1.3 for its industry on average. Its price-to-cash flow is particularly attractive at 7.6 versus 12.2 for its respective industry. With a forward P/E of 25.5, the REIT is trading at a discount to its industry on average (with a forward P/E of 30.1). Analysts are very positive on the company given its attractive dividend yield, which is supported by predictable cash flows. As regards the hotel market outlook, the sector's fundamentals have improved greatly since the Great Recession, and the overall hotel market is on the long path to recovery. As regards Hospitality Property Trust's competitors, Host Hotels & Resorts Inc. (HST) and Hersha Hospitality Trust (HT) pay lower dividend yields of 2.4% and 5.1%, respectively. Hospitality Properties Trust units are up almost 4% from the year ago. Billionaires Cliff Asness and Israel Englander have minor stakes in the company.
Aspen Insurance Holdings Ltd. (AHL) is the 17th-biggest position in Dreman's portfolio. His stake in the company is currently valued at $36 million. This global specialty insurance and reinsurance company pays a dividend yield of 2.2% on a low payout ratio of only 19%. Its peers ACE Limited (ACE) and XL Group Plc (XL) pay dividend yields of 2.4% and 1.8%, respectively. Aspen insurance Holdings Inc.'s stock is priced below book value at a ratio of 0.6 versus 0.8 for its respective industry. Its price-to-cash flow of 5.5 is also lower than the industry's average of 6.1. With a forward P/E of 14.8, the stock is priced well below the property and casualty industry's average ratio of 37.7. The stock's free cash flow yield is 13.8% and its ROE is 7.9%, slightly higher than the industry average of 7.3%. Year-over-year, the insurer's gross and net written premiums grew by 14.8% and 15.0%, respectively, for the nine months ending Sept. 30, 2012. The EPS for the same period was $3.47 compared with a loss of $1.98 in the year-earlier period. The stock has a long-term EPS growth projection of 12.5%. The shares are up 20.5% over the past year. Among fund managers, the stock is also popular with billionaire David Einhorn of Greenlight Capital (check out his portfolio).
Portland General Electric Company (POR) is another value, dividend-paying pick in Dreman's portfolio. The stake was worth $35 million at the end of the third quarter. The company is an integrated electric utility serving customers in the state of Oregon. The stock pays a high dividend yield of 4.0% on a payout ratio of 58%. Its competitors Avista Corp. (AVA) and IdaCorp (IDA) pay dividend yields of 4.8% and 3.5%, respectively. Portland General Electric Company's price-to-book of 1.2 is below the industry average of 1.3; its price-to-sales of 1.1 compares with the industry average of 1.4; and its price-to-cash flow of 4.1 is lower than the industry average of 6.5. With a forward P/E of 14.2, the stock is priced at a discount to the alternative electricity industry with the ratio of 20.2. The company's EPS growth is expected to average 4% per year for the next five years. Future growth could accelerate once the company installs new generation capacity. In fact, the company is currently reviewing 32 bids for 15 different generating projects to meet Oregon's future energy demands. Portland General Electric Company's shares are up nearly 11% over the past 12 months. Adage Capital (check out its top picks) initiated a new position in this stock in the third quarter.