5 Stocks Yielding Over 7% To Buy With Upside And Reasons To Rally

Includes: CLF, CTL, FTR, PBI, WIN
by: David Alton Clark

The Gist

The following is an update to an article I wrote previously regarding these stocks. Significant events in the macro environment and with some of the stocks individually have taken place that has prompted me to perform a review of my prior positions. It is part of my normal modus operandi to review my positions at least once a quarter or any time a major macro event, such as the fiscal cliff, occurs.

These five stocks are from S&P 500 U.S. companies with market caps of 2 billion or better which pay dividends yielding over 7%. Moreover, most of these stocks have recent upgrades and positive analyst comments. Some have recent negative comments or their earnings results and are down significantly, presenting a buying opportunity.

There may be more volatility in front of us with the year coming to a close and the fiscal cliff still unresolved. Nevertheless, this may be a good point to start a position in these high-yield dividend-paying opportunities. A model investing approach is to construct a diverse portfolio of stocks with significant capital gain potential and exceptional dividend yields.

With the Fed keeping interest rates at all-time lows for the foreseeable future, investors are being driven to dividend paying stocks in a search for yield. This should create substantial demand for these stocks over the coming years.

Furthermore, these dividend-paying stocks have the potential for both capital gains and income production. Most of these stocks are trading near 52 week or multi-year lows and have substantial upside based on analysts' mean price targets. This combination of capital gains and income production will be necessary to fund the lengthening retirement that comes with a greater life expectancy for investors.

The Goods

In the following sections, we will perform a review of the fundamental and technical state of each company along with any potential catalysts for growth to determine if this is the right time to start a position in these stocks. The following table depicts summary statistics and Tuesday's performance for the stocks.

Cliffs Natural Resources Inc. (CLF)

The company is trading 58% below its 52-week high and has 45% upside potential based on the consensus mean target price of $46.06 for the company. Cliffs was trading Tuesday for $31.79, up over 3% for the day.

Fundamentally, Cliffs has several positives. Cliffs pays a dividend with a yield of 8.10%. The company has a forward P/E of 10.18. Cliffs is trading for a 31% discount to book value. EPS is up over 50% this year. The company has a net profit margin of 16.28% and the current ROE is 15%.

Technically, Cliffs is in a well-defined downtrend yet recently found support at the start of December and may have found a bottom. The stock recently took a serious nose dive after missing earnings. Cliffs reported third-quarter results that missed analysts' estimates as the price of steel making raw-materials dropped. Then the stock took another dive on a Goldman Sachs downgrade. Goldman downgraded Cliffs shares to Sell with a $25 price target.

Previously, I suggested using the $25 price target set by Goldman as your entry point. The stock doesn't seem like it's going to make it. Spot iron ore prices rose Tuesday to their highest level since July, underpinned by buying from China. This bodes well for Cliffs. The risk/reward at that level seems favorable at this level. I like the stock here.

CenturyLink, Inc. (CTL)

The company is trading 9% below its 52-week high and has 17% upside potential based on the consensus mean target price of $44.94 for the company. CenturyLink was trading Tuesday for $38.59, up over 1% for the day.

Fundamentally, CenturyLink has some positives. CenturyLink pays a dividend with a yield of 7.63%. CenturyLink's forward P/E ratio is 14.30 and the company is trading at 1.2 times book value. The company's revenue growth has surpassed the industry average of 7.4%. Profits and revenues are up and the company has raised guidance. EPS is up nearly 100% quarter over quarter.

Technically, CenturyLink seems to be in the midst of a trend reversal. The stock has breached the last resistance level at the 200-day sma and is now trading 1% above it. The stock is in good shape.

Jennifer Fritzsche, an analyst at Wells Fargo, says, "CenturyLink is generating north of $5 per share in free cash flow, among the best of any wireless or wireline carrier." She credits CenturyLink's cash flow management for the payment of a dividend yield well above that of AT&T (NYSE:T) or Verizon (NYSE:VZ). "With interest rates in the 1% to 2% range, this is more like a bond," Fritzsche says.

I agree with Fritzsche and believe Century link is well positioned for revenue growth after several years of declines. The telecom sector is growing by leaps and bounds with the proliferation of smartphones and mobile communications devices. The stock is a buy here.

Frontier Communications Corporation (FTR)

The company is trading 6% below its 52-week high and has 8% upside potential based on the consensus mean target price of $5.11 for the company. Frontier was trading Tuesday for $4.72, up slightly for the day.

Frontier has some fundamental positives. Frontier pays a dividend with a yield of 8.49%. The company is trading for slightly over book value, 93% of sales and has a forward P/E of $18.84. The company's gross margin is 91.03%. The stock is trading for 20 times free cash flow.

Technically, Frontier has been in an uptrend since May. The golden cross was achieved at the beginning of September. This is a very bullish development. The stock tested the bottom of the current uptrend channel for the second time in mid-November after receiving a downgrade to Sell from Goldman. Nevertheless, it has rallied significantly since then.

Goldman argues the carrier's cost structure is deteriorating thanks to a mix shift to lower-margin services. Even so, Frontier recently announced earnings that met top and bottom line estimates. On a positive note, Frontier's 2012 free cash flow guidance was unchanged at $900M-$1B.

I see the recent pullback as a buying opportunity and the 9% dividend provides some insurance. Moreover, as stated previously, the telecom sector is on fire. One caveat is the stock has a high short interest. This can either be seen as a negative or a positive depending on your point of view. Nonetheless, I like the stock here, Frontier is currently trading at decade lows and a high short interest provides the opportunity for a significant short squeeze.

Pitney Bowes Inc. (PBI)

The company is trading 38% below its 52-week high and has 39% upside potential based on the consensus mean target price of $15.25 for the company. PBI was trading Tuesday for $11.00, up slightly for the day.

PBI has some fundamental positives. PBI pays a dividend with a yield of 13.71%. The company is trading for 43% of sales and has a forward P/E of 5.79. The company's net profit margin is 7.57%. According to Finviz.com, the company has a ROE of 935%. The company is increasing profit margins and cash flow from operations is healthy. The stock is trading for 15 times free cash flow which is great.

Technically, PBI has been trading sideways since May and took a nose dive after missing earnings estimates on November 1st. The stock has been consolidating at the 52 week low for the past month.

PBI reported third quarter 2012 earnings per share of 38 cents, lower than the Street's expectations. I see this as a buying opportunity. Cash flow and net income have been trending up for the last few years. The cash flow seems adequate to cover the dividend. The only threat is a series of debts that will be maturing over the next several years.

The great news is PBI recently announced that the PBI Board of Directors has appointed Marc B. Lautenbach as President and Chief Executive Officer, effective immediately. Mr. Lautenbach joins Pitney Bowes with nearly 30 years of experience in the technology and business services industry, having served in senior leadership positions at IBM (NYSE:IBM). I am familiar with Lautenbach's work with IBM and have the utmost respect for his talents and leadership skills. This was a huge coup d'état for the company. I like the stock here.

Windstream Corporation (WIN)

The company is trading 28% below its 52-week high and has 20% upside potential based on the consensus mean target price of $10.13 for the company. Windstream was trading Tuesday for $8.39, up slightly for the day.

Windstream has some fundamental positives. Windstream pays a dividend with a yield of 11.93%. The company is trading for approximately one times sales and has a forward P/E of 15.24. Sales are up 50% quarter over quarter. The company's gross profit margin is 52.60%. The company has a ROE of 13%. The company is increasing profits margins and cash flow from operations is healthy.

Technically, Windstream is in a downtrend but seems to have found a bottom at the $8 mark in mid-November. The stock took a major nosedive after missing earnings expectations, albeit by just a hair. The stock has been under accumulation for the last month and has risen 5% over that time period piercing the 20-day sma resistance line.

Windstream missed EPS by one cent yet reported revenues in-line. Goldman subsequently downgraded Windstream to a Sell citing margin pressure. The stock tested support at the bottom of the long-term downtrend channel. Support held and now I see this as an excellent buying opportunity.

Frost & Sullivan recently recognized Windstream for its growth in the Ethernet services market. Closely monitoring the booming Ethernet market, Frost & Sullivan believes Windstream has positioned itself for robust and sustained growth. This news is hot off the presses and I do not believe the potential upside is priced in to the stock as of yet. The stock is a buy at this level.

The Bottom Line

These stocks have solid long-term growth stories and pay hefty dividends. These facts coupled with the Fed's announcement that rates will remain at ultra-low levels for at least the foreseeable future leads me to believe these stocks are a better hedge against inflation than fixed income instruments such as bonds and CDs. Factor this in with the statistic that historically dividend-paying stocks have outperformed non-dividend-paying stocks and you have a recipe for outstanding returns. If you choose to start a position in any stock, I suggest layering in a quarter at a time at a minimum to reduce risk.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in WIN, PBI, CTL, CLF, FTR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this article is for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment.