By Jake Mann
In the midst of government indecision in the United States, investors of all types are feeling uncertain. With the pundits, economists, experts, and just about everybody else split on what 2014 will bring, one thing is clear: there isn't an overabundance of value opportunities in the market at the moment.
This is a point that Warren Buffett harped on last month, when he told the media that Berkshire was "having a hard time finding things to buy," and it's at least partially evident in the metrics as well. The current price-to-earnings multiple of the S&P 500 is just above 19, versus an average of 18.6 since 1960.
For the regular dividend investor focused on capital preservation, this data may not be too worrisome. Anyone looking for a little bit of extra appreciation with those dividends, whether it's value- or growth-based, might be a bit more concerned. If you consider yourself to fall in line with the latter group, there's one other way you can find dividend-payers with a greater upside than some of the stalwarts: stocks with abnormally low payout ratios.
Let's take a look at two great examples of these types of dividend stocks. Both sport existing dividend yields above 3%, and pay a lower percentage of their earnings out as dividends than peer averages dictate they should. In fact, of all S&P-listed stocks with yields of at least 3%, this duo offers the two lowest payout ratios on the market.
Of the entire universe of S&P 500-listed stocks with dividend yields of at least 3%, Ensco (ESV) has the lowest payout ratio. Over the past twelve months, the offshore contract driller has paid just 18.5% of its earnings out to shareholders in the form of dividends. Ensco has doubled its quarterly dividend over the last three years, and now offers a 3.6% yield. When looking at the oilfield services and equipment industry as a whole, Ensco is attractive for two reasons.
First, its peer group-comprised of companies like Seadrill (SDLP) and Transocean (RIG)-averages a higher payout ratio near 23%. If Ensco were to simply meet industry norms, its dividend yield would theoretically rise above the 4.5% mark. Likewise, a payout similar to that of Seadrill (34%) or some of the more generous players in this space would net Ensco investors a whopping dividend yield of above 6.0%.
Secondly, Ensco's promising growth potential indicates that it should have the ability to continue expanding its dividend payments. Wall Street expects a generally bullish offshore drilling environment to boost earnings at the company by over 15% a year through 2018. With close to the same number of rigs operating in Asia as it has in North & South America (22 vs. 20), Ensco gets the added bonus of working in one of the highest-growth drilling regions on the planet. Even if the company's payout ratio stays below industry norms in the intermediate term, these prospects make it a very real possibility that dividends could again double in the next three years.
Pharmaceutical giant Pfizer (PFE), meanwhile, currently pays dividends out at the second lowest percentage of earnings among all S&P stocks with at least a 3% yield. Pfizer sports a payout ratio of 25%, far below the drug industry's average of about 48%. Although it did slash its quarterly dividend in half at the end of the financial crisis, Pfizer has since reinstated 50% of this cut and at current prices offers a yield of 3.3%.
Like Ensco, the earnings picture is attractive enough to assume that Pfizer should be able to reach pre-crisis dividend levels within the next few years. This would represent a yield of 4.4% based on current prices. Pfizer has beaten analysts' EPS estimates in three of its last five quarters and China, which registered a 22% y/y growth last quarter, has been a big reason behind this progress. Dividend investors interested in buying now also have a couple of structural changes they should know about.
Following the divestiture of its nutritional business and the spin-off of its animal health company Zoetis (ZTS), it is widely expected that Pfizer will separate its branded and generic divisions internally, with the latter prone to a spin off or sale. An outright sale of Pfizer's generics business would be the most shareholder-friendly move. The segment, which generated over $10 billion in sales last year, could theoretically fetch at least twice that value on the open market if a buyer could be found. It's not unreasonable to think that a dividend boost could be the eventual result if Pfizer did choose to go this route.
Even if this scenario does not work out exactly how income-seeking investors may hope, the company still has the potential to increase dividend payments organically over the long run.