I am a firm believer in the relevance of low interest rates to equity values and that relevance tends to manifest itself first in the valuations of stocks paying generous dividends because those stocks are more attractive from a yield perspective than fixed rate alternatives. We have already seen a big run up in utility and telephone stocks and the theme is likely to continue to be played out in 2013. It is harder and harder to find stocks with big dividends that do not have problems of one kind or another because stocks with big dividends and no problems go up in price and this drives the dividend yield down.
I have identified four stocks paying high dividends which have the potential to achieve substantial appreciation in 2013. Obviously, the reason that each of them is trading at a price which produces a high dividend yield is that there is some risk in each of these situations. Nevertheless, on balance, each of these stocks promises more upside than downside, and an investor who spreads his risk by buying them all is likely to do very well. The table below provides Friday's closing price, the current annual dividend, the dividend yield, current year earnings, and the price earnings ratio for Seagate Technology (NASDAQ:STX), United Online (NASDAQ:UNTD), GameStop (NYSE:GME), and Tronox (NYSE:TROX).
STX earnings are for the fiscal year that ended June 29, 2012, based on SEC filings; all other earnings are consensus analyst earnings estimated for the current fiscal year as reported by Yahoo Finance.
Each of these companies has the demonstrated capacity to generate earnings and cash flow at rates very attractive in comparison with their current market caps. In each case, there is a problem but also a possible upside scenario. The market's "risk on, risk off" rollercoaster has undervalued each of these companies and, in each case, I believe that value will reassert itself.
I have recently written about STX here. STX is a victim of the "Short the PC" wave of sentiment as well as a perception that the hard disk drive market is destined to experience price wars and declining volumes. The reality is that more and more demand for hard disk drives is being accounted for by needs for external storage and that this is not dependent upon the volume of PC sales. Pricing is likely to hold up because the hard disk drive industry has recently gone through a wave of consolidation resulting in a virtual duopoly. Earnings are likely to decline because fiscal 2012 was an amazing year for STX, but with a shareholder friendly management, a steady stream of share repurchases, and a more stable pricing atmosphere, STX is seriously underpriced here.
UNTD has rebuilt itself and has a strong subsidiary in FTD (the flower delivery business) which it has announced it is likely to spin off in 2013. Trading alone, FTD will be a solid money machine and will likely trade at an attractive multiple. The "stub" (the remainder of UNTD) includes attractive internet assets including Classmates and other enterprises which have over 100 million registered accounts. Classmates allows subscribers to network with fellow alums and relive their high school and college years. While many of us may not find going through the high school experience again an enticing offer, there seem to be a large enough pool of participants to offer a variety of attractive monetization opportunities, some of which are already underway. The stub will probably trade as a more speculative, growth opportunity. Management has been adroit at skating through some thin ice and I think that they will manage the spin off to the advantage of shareholders.
GME lives in the shadow of the Blockbuster debacle with investors fearful that a bricks and mortar retail strategy is a dead end and GME will face inevitable decline in volume and profit. However, the last quarter of 2012 and all of 2013 will see new consoles penetrating the market and should produce a nice uptick in activity. In addition, GME has an "own the customer" strategy focused on developing customer loyalty. It also has a valuable franchise in its dominance of the reused game market popular with younger gamers. GME is shareholder oriented with considerable stock repurchase activity. If it can simply hold its own or even manage a modest decline in volume, it could be a great value at this price.
TROX is a leading producer of titanium dioxide used in plastics and essential to the production of quality white paint. Inventories are high and a dip is working itself out, but a rebound is likely if the housing market begins its return to normal. Barron's has recently written up TROX favorably in this article. It also has a massive lawsuit against its former parent which could put icing on the cake.
In each of these cases, the company has proven earnings power and valuable assets. In the case of STX and GME, all you really need to do well is for the company to avoid a steep decline; a modest decline could leave you in very good shape. TROX needs a recovery in the paint business, but we have been building housing units way below trendline for 4 years now and, sooner or later, pent up demand will assert itself and we will get back over one million units a year. UNTD just has to manage the spin-off of FTD successfully to produce combined shareholder value in the spin off and the stub well above current share price.
I would be grossly misrepresenting the situation if I were to characterize any of these as risk free. These are not franchise utility stocks. There is real risk but the reward is asymmetric to the risk. And, of course, you get paid nicely to wait for the value to unfold.