By Matt Doiron
One common measurement of a stock's upside potential is the PEG ratio, which takes into account both the P/E multiple and analyst consensus for future earnings growth rates. Analysts aren't always correct, and so their projections shouldn't be taken as fact, but this is at least one way to account for a company's growth potential and is therefore a way to measure the stock's possible upside. Because the PEG ratio is a quantitative screen we can combine it with other screens (for example, stocks with high dividend yields) in order to identify initial investment ideas. Using data from Fidelity, here are five stocks with dividend yields of 4% or higher at current prices and with five-year PEG ratios lower than 1:
Leading our list is Transocean (RIG), the $17 billion market cap offshore drilling contractor. the stock's dividend has recently been increased and at this point its annual yield is 4.7%. In addition, while trailing earnings have been fairly low relative to Transocean's valuation, Wall Street analysts are optimistic about offshore drilling in general. Their predictions for future earnings growth result in Transocean's forward earnings multiple being only 8 with a PEG ratio well below 1. There is some macro risk here- the stock's beta is 1.9- but it does look worthy of further research.
Insider Monkey tracks quarterly 13F filings from hundreds of hedge funds, using the results to help us develop investment strategies (for example, we have found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year). We can see from our database that billionaire Carl Icahn's Icahn Capital owned more than 20 million shares of Transocean at the end of March, giving the activist more than $1 billion invested in the stock. Find Icahn's favorite stocks.
Another offshore driller meeting our criteria is SeaDrill (SDRL), which is a similar size to Transocean in terms of market cap at $20 billion. As with its peer, the sell-side is expecting high future earnings growth from SeaDrill. These projections place the stock's current price in line with a PEG ratio of 0.7, and at least in terms of revenue the company has been growing recently. Dividend payments do tend to fluctuate but the yield certainly seems to be above 4% and likely considerably higher. Renaissance Technologies, founded by billionaire Jim Simons, reported a position of 4.7 million shares in SeaDrill as of the end of March (see Renaissance's stock picks).
Corrections Corporation (CXW) is another high yield stock beloved by the sell-side. The company, which owns and operates prisons and other facilities, saw its revenue decline slightly in the first quarter of 2013 versus a year earlier with pretax income down 9%. Analysts expect it to recover, however, with Fidelity giving the PEG ratio as 0.8. Assuming a quarterly payment of 48 cents per share, the dividend yield is 5.7% at current prices and defensive investors should note that the beta is only 0.5. However, many bears argue that political pressure and/or budget pressure will cool states' interest in privatized prisons.
Also offering a high yield- though in this case investors should be aware of any tax issues- is Canadian Imperial Bank of Commerce (CM). The annual yield is nearly 5%, and from a value perspective the stock appears to be a good deal in quantitative terms as well: the trailing and forward P/Es are both 9. Revenue and net income were both up modestly in its most recent quarterly report compared to the same period in the previous fiscal year, and with analysts expecting that to continue the PEG ratio is 0.9. We're not as familiar with Canadian banks as U.S. ones, but income investors could certainly look into how their tax situations handles foreign dividends.
A similar situation applies for Bank of Nova Scotia (BNS). This Canadian bank trades at 10 times earnings, whether we consider trailing results or analyst forecasts for the fiscal year ending in October 2014. In its fiscal Q2, revenue and earnings increased 10% from their levels a year ago and that is roughly the average EPS growth rate that the Street is looking for over the next several years resulting in a PEG ratio less than 1. The dividend yield is 4% at current levels though of course investors would have to look into how that would be taxes and any concerns over the Canadian housing market and banking system in general.