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Do you prefer stocks that pay dividends you can rely on? We ran a screen with this idea in mind.

We began by screening the S&P 500 for dividend stocks paying yields between 1-5%, and with sustainable payout ratios below 50%. We excluded stocks with yields above 5% so that we could avoid the riskier high-yield stocks.

Then we screened our list of stocks for those that appear undervalued relative to the Graham Number. The Graham Number is a measure of maximum fair value created by the "godfather of value investing," Benjamin Graham.

It is based off of a stock's EPS and book value per share (BVPS).

Graham Number = SQRT(22.5 x TTM EPS x MRQ BVPS)

The equation assumes that P/E should not be higher than 15 and P/BV should not be higher than 1.5. Stocks trading well below their Graham Number may be undervalued.

Our final list consisted of 3 stocks that met the above defined criteria.

A Closer Look

We looked at Safeway (NYSE:SWY) in more detail. We first looked at the company's 13F to research institutional activity in the stock. We found net institutional purchases in the current quarter at 14.0M shares, which represents about 5.91% of the company's float of 236.97M shares. The 2 top holders of the stock are FMR, LLC, and The Vanguard Group.

The stock trades around $20.42 versus the 52-week range of $14.73-$23.16, down 8% in the past 1-year. It trades with a P/E multiple of 10 times. Its competitor The Kroger Co. (NYSE:KR) trades with a P/E multiple of 11 times, and pays a dividend of 2%. Also, Supervalu (NYSE:SVU), which has been down 44% in the past 1-year, trades with a P/E multiple of 9 times, and does not pay a dividend.

Safeway will report earnings on February 21st, 2013. The company is expected to report a profit of $0.77 a share, a 15% increase in earnings from last year. The high estimate is $0.82, and the low estimate is $0.73.

Do you think its time for you to get involved in Safeway?

The List

For an ‪interactive version of this chart, click on the image below. Analyst ratings sourced from Zacks Investment Research.

Do you think these stocks pay sustainable dividend yields? Use this list as a starting point for your own analysis.

1. AFLAC Inc. (NYSE:AFL): Provides supplemental health and life insurance.

  • Market cap at $22.9B, most recent closing price at $49.34.
  • Diluted TTM earnings per share at 6.11, and a MRQ book value per share value at 34.16, implies a Graham Number fair value = sqrt(22.5*6.11*34.16) = $68.53. Based on the stock's price at $50.35, this implies a potential upside of 36.1% from current levels.
  • Dividend yield at 2.8%, and payout ratio at 22%.

2. Humana Inc. (NYSE:HUM): Offers various health and supplemental benefit plans in the United States.

  • Market cap at $12.31B, most recent closing price at $77.99.
  • Diluted TTM earnings per share at 7.47, and a MRQ book value per share value at 55.88, implies a Graham Number fair value = sqrt(22.5*7.47*55.88) = $96.91. Based on the stock's price at $81.35, this implies a potential upside of 19.13% from current levels.
  • Dividend yield at 1.3%, and payout ratio at 14%.

3. Safeway Inc. : Operates as a food and drug retailer in North America.

  • Market cap at $5.B, most recent closing price at $20.42.
  • Diluted TTM earnings per share at 2.11, and a MRQ book value per share value at 11.6, implies a Graham Number fair value = sqrt(22.5*2.11*11.6) = $23.47. Based on the stock's price at $20.2, this implies a potential upside of 16.17% from current levels.
  • Dividend yield at 3.5%, and payout ratio at 31%.

*BVPS and EPS data sourced from Yahoo! Finance, all other data sourced from Finviz.

Source: 3 S&P 500 Dividend Stocks Undervalued By The Graham Number