10 High-Quality Dividend Growth Stocks Trading Well Below Fair Value

by: FerdiS

A history of dividend yields can be used to establish undervalued (and overvalued) price targets for high-quality dividend growth stocks.

Plotting price lines that correspond to undervalued and overvalued yields forms a yield channel that I find to be useful in making timely investment decisions.

This article presents ten high-quality (and safe) dividend growth stocks trading at undervalued yield levels. Readers may want to consider these stocks as potential buys.

I'm rebooting my series of DivGro Pulse articles to focus on high-quality dividend growth stocks trading at extreme yield levels.

When such stocks are trading at historically high yields, they are undervalued and worth considering as potential buys. Conversely, when these stocks are trading at historically low yields, they are overvalued and candidates for potential sells.

Last year I wrote an article about Yield Channel Charts, a tool for dividend growth investors to assess market valuation relative to historical yield patterns. Yield channels can be seen as "safety zones" for stock prices. As long as the stock price stays near the center of the yield channel, the stock is fairly valued.

In this article, I present yield channel charts for ten high-quality dividend growth stocks trading at undervalued yields. These are stocks I happen to own in my DivGro portfolio of 83 different positions, including 74 dividend growth stocks. In time, I hope to expand the number of dividend growth stocks I regularly monitor to about 120 stocks. The stocks I don't own will become my watch list stocks.

For each stock, I provide a short description of the company, a 7-year yield channel chart created from weekly yield data, and some key metrics to help with a superficial analysis of each stock. In addition to the price and yield, I provide 1-year and 5-year dividend growth rates, as well as the quality indicators used by David Van Knapp in a recent article:

See David's article for a description of each provider's quality indicators.

Additionally, I use the average dividend yield method to estimate a reasonable fair value estimate of each stock. To do so, I rearrange the dividend yield formula:

current dividend yield = 100 × annual dividend / current stock price

as follows:

fair value price = 100 × annual dividend / average dividend yield


fair value price = current stock price × (current dividend yield / average dividend yield)

Without further ado, here are the ten stocks:

1. 3M (MMM)

MMM is a diversified technology company with worldwide operations. The company has leading positions in consumer and office; display and graphics; electronics and telecommunications; healthcare; industrial; safety, security and protection services; transportation; and other businesses. MMM was founded in 1902 and is headquartered in St. Paul, Minnesota.

After making a high near $260 per share in January 2018, MMM dropped to breach the undervalued yield level twice (in October and December 2018). Those would have been ideal opportunities to buy MMM shares. I was a little late with buy on March 11; nevertheless, the buy resulted in a solid yield on cost (YoC) of 2.80%. MMM now yields 2.67%.

2. Walt Disney (DIS)

DIS is a diversified international family entertainment company based in Burbank, California. Founded in 1923 by Walt Disney and Roy O. Disney, the company established itself as a leading animation studio before diversifying into other entertainment-related segments. Today, DIS operates in four segments: Media Networks, Parks & Resorts, Studio Entertainment, and Consumer Products & Interactive Media.

The stock price of DIS has been marking time since about July 2015. In contrast, the company has increased its dividend at a reasonable pace (the 5-year DGR is 15.4%). As a consequence, the upward trending yield channel has caught up with the stock price and DIS has traded at the undervalued yield level on several occasions. DIS is my third-largest position, so I'm not planning on adding more shares at this time.

3. Amgen (AMGN)

Based in Thousand Oaks, California, AMGN is a biotechnology company. The company discovers, develops, manufactures, and delivers human therapeutics worldwide. It offers products for the treatment of serious illnesses in the areas of oncology/hematology, cardiovascular disease, inflammation, bone health, nephrology, and neuroscience. AMGN was founded in 1980.

AMGN has a very similar yield channel chart than DIS, with several opportunities offered since the end of 2016 to buy shares at undervalued yield levels. It appears that AMGN's current price presents another great opportunity to secure a high yield. I've added to my initial position on two occasions, in December 2018 and again in February 2019. The average YoC of my AMGN position is 3.06%.

4. Coca-Cola (KO)

KO is the world's largest beverage company and the leading producer and marketer of soft drinks. Along with Coca-Cola, recognized as the world's best-known brand, The Coca-Cola Company markets four of the world's top five soft drink brands, including diet Coke, Fanta, and Sprite. KO was founded in 1886 and is headquartered in Atlanta, Georgia.

My KO position is medium-sized and has an average YoC of 3.88%. I opened my KO position in March 2014 and added to my position on three different occasions. The best initial YoC of 3.34% (for a December 2016 buy) compares well to KO's current dividend yield. I have some concerns with KO's decreasing dividend growth rate, though.

5. Exxon Mobil (XOM)

XOM is the world's largest publicly traded international oil and gas company. Founded in 1882 and based in Irving, Texas, the company is engaged in oil and natural gas exploration and production, petroleum products refining and marketing, chemicals manufacture, and other energy-related businesses. The majority of XOM's earnings come from operations outside the United States.

December's stock market decline created lots of opportunities for dividend growth investors, and XOM is a great example! I added to my position in early December at an initial YoC of 4.25%. Even following the recent upsurge, XOM still offers a yield of nearly 4%. I'm not looking to add to my medium-sized position right now, but XOM is worth considering, in my view.

6. Chubb (CB)

CB is the world’s largest publicly traded property and casualty insurance company with operations in more than 50 countries. The company offers commercial and personal property and casualty insurance, personal accident and supplemental health insurance, reinsurance, and life insurance to a diverse group of clients. CB was founded in 1985 and is headquartered in Zurich, Switzerland.

I've owned CB since November 2013, and while my annualized total return is "only" 9%, I'm quite happy with my investment. CB provides a safe dividend, which has increased every year for 25 years. Now can be a good time to add shares of CB.

7. International Business Machines (IBM)

Founded in 1910 and headquartered in Armonk, New York, IBM is a global information technology (IT) company that offers consulting and application management services, IT infrastructure services, and infrastructure technologies. IBM’s Watson is a cognitive computing platform that interacts in natural language, processes big data, and learns from interactions with people and other computing systems.

I've patiently held on to my IBM position and, while the stock's yield is attractive, the stock price has not played along! The stock price dropped significantly in September 2018, providing dividend growth investors with a great opportunity to buy shares well outside the 7-year yield channel. I have a smaller position in IBM, but I'd like to see stronger evidence of a turnaround before I'll consider adding more shares.

8. FedEx (FDX)

Founded in 1971 and headquartered in Memphis, Tennessee, FDX provides transportation, e-commerce, and business services worldwide. The company's Express segment offers shipping services for delivery of packages and freight, while its Ground segment provides business and residential ground package delivery services. FDX also operates in the Freight, Services, and Corporate, Other and Eliminations segments.

FDX is one of my recent additions. I opened a small position in February and now seems to be a great time to consider adding more shares. For comparison, my initial YoC of 1.45% is somewhat higher than the current dividend of 1.37%. Notice, though, that FDX is growing its dividend at a spectacular rate of over 30%, which is one of the main reasons I invested in FDX. I like to have some positions in my portfolio with higher dividend growth rates even if I have to settle for lower yields.

9. United Parcel Service (UPS)

UPS is a global leader in logistics, offering a broad range of solutions including the transportation of packages and freight, the facilitation of international trade, and the deployment of advanced technology to more efficiently manage the world of business. Headquartered in Atlanta, UPS serves more than 220 countries and territories worldwide.

My UPS position is one of my smaller positions. With an average YoC of 3.75%, I'm reasonably happy with my investment although I do notice that UPS' dividend growth is slowing down. Still, the company pays a decent dividend.

10. AT&T (T)

Incorporated in 1983 and based in Dallas, Texas, T is a holding company providing telecommunications services across the world. These services include wireless communications, data/broadband and Internet, video, local exchange, long-distance, managed networking, and wholesale services. Through DIRECTV, a subsidiary, T provides pay television in the United States and internationally.

Finally, T's stock has been declining since January 2017, and the stock has moved outside the 7-year yield channel chart on several occasions. I think T will be fine in the long run, though it is struggling to hit deleveraging targets following its acquisition of Time Warner. Currently, T yields an impressive 6.31%, though one would have to settle for a very low dividend growth rate. I already own a large position in T, so I'm not currently looking to add shares, even though that dividend yield is very tempting.

Fair Value Adjustment

I prefer to buy shares when stocks are discounted by at least 10%, though I'm willing to pay up to fair value in certain scenarios, such as to establish a small position in a high-quality dividend growth stock that rarely trades below fair value.

Although the fair value estimates provided above are reasonable valuations for high-quality dividend growth stocks, I often reference fair value estimates and target prices from other sources as a way to "calibrate" my own estimates.

Below, I'm providing a summary of the key metrics presented earlier, but I'm replacing the Fair Value Estimate column with a collated fair value estimate based on fair value estimates and target prices from the following sources:

  • Finbox.io: fair value estimate based on several financial models
  • Morningstar: fair value estimate based on discounted cash flow analysis
  • Simply Wall St: future cash flow value using 2-stage discounted cash flow analysis
  • TipRanks: average of analyst price targets
  • Value Line: average of target range
  • Yahoo! Finance: average of analyst price targets
  • CFRA: fair value calculation based on CFRA's proprietary quantitative model

Given up to eight different estimates, my final fair value estimate ignores the outliers (the highest and lowest values) and average the median and the mean of the remaining values.

Notice that after collating the fair value estimates and price targets, MMM appears to be trading at a premium to fair value. Furthermore, four stocks are trading at discounts of at least 10%. Of these, my position in FDX is the smallest, so I'll be looking at adding to my FDX position first. AMGN offers a higher yield, so I'll consider increasing my medium-sized position in AMGN as well. I'll hold off on adding to DIS and T, as these are some of my largest positions.

Concluding Remarks

After a hiatus, I'm rebooting my series of DivGro Pulse articles to focus on high-quality dividend growth stocks trading at extreme yield levels. I'm using weekly data to create 7-year yield channel charts that graphically show when stocks are trading at historically high (or low) yields. When this happens, the stock is undervalued (or overvalued) and is a candidate for buying (or selling) shares.

Yield channels can be seen as safety zones for stock prices. As long as the stock price stays near the center of the yield channel, the stock is fairly valued.

I presented yield channel charts for ten high-quality dividend growth stocks trading at undervalued yields. I own these stocks in my DivGro portfolio, so this analysis will be useful when I have extra cash to spend.

In time, I hope to expand the number of dividend growth stocks I regularly monitor in my DivGro Pulse articles to about 120 stocks. The stocks I don't own will become my watch list stocks.

Soon, I'll write a companion article to this one focusing on high-quality dividend growth stocks that are trading well above fair value. Such stocks are overvalued relative to historical yield patterns and may be considered as candidates for divestment.

Thanks for reading and happy investing!

Disclosure: I am/we are long T. 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.