A Dividend Stock From Each Sector - May 2020
Summary
- We've entered a period of some recovery. As a result, the companies which only weeks ago were cheap, are no longer available at a good price.
- We need to start either accepting a premium from a desired fair value, or look to different-tier companies, or the ones still available at a discount.
- I choose the latter at this time - and I show you what companies these are.
During the past few weeks, the discounts we've been enjoying in key quality stocks have disappeared. Coca-Cola (KO) at 4% yield? Forget it. Johnson & Johnson (JNJ) at 3%+? No more. Even a few mid-range stocks in terms of quality have picked up steam, and the three-digit discounts that were available in some financial stocks have quickly turned into high double-digits, heading for low double-digits.
Countries are potentially opening things back up again. Things are, people hope, slowly and potentially starting to return to normal.
Now, I've no doubt that this may be a bit of a "fool's" rally, and that we're headed down again, at least to some extent. I'll admit though, that I have a hard time seeing the catalyst for a serious, 5-15% drop from these levels. I don't believe a higher corona case number will do it, nor higher mortality rates. The market has been conditioned to the bad news involving corona. I don't have a crystal ball, but two things make me continue investing at this time.
- I don't know if the market is actually going to go seriously back down from these levels.
- Even if it does, the companies I'm looking at at the prices I'm paying are still pretty amazing deals, all things considered, and in the very long run.
- I try not to care about the overall market, but focus on individual companies.
So, that being cleared up, it's time to present some of the potential candidates for May, or at least these coming few weeks in May. For the sake of this article, I'll focus on the businesses in my watchlist and model which correspond to an NA geography rather than international. A few reasons for this, but for the most part I find it useful to keep these recommendations separate at this time.
One of the common mistakes I find people doing is basically two sides of the same coin. Either not diversifying too much, and as a result being too exposed to any one particular sector, equity or dividend, or diversifying for the sake of it, which is equally wrong in my eyes. It's about good companies at good prices. There's no reason to buy a different good company, if your already-invested good company offers a higher upside at a similar price.
With that said, let's get into it!
Discounts still available - a few examples
Previously, I highlighted companies in every sector and segment.
I'll take a similar tact in this article. The purpose here is a quick review of the potential discounts you may take advantage of at this time in the market, together with their corresponding upsides. To be the most accurate and fair here, the companies I will present are the ones I consider the highest quality together with the highest potential upside. The companies that, in this case, combine these two qualities into an appealing buy.
In the Basic Materials segment, we find that Eastman Chemical Company (EMN) still gives us a ~22% discount to what I would consider fair value. I've written on the company before, and Eastman is the only Class-1 company in the sector with a 4%+ yield that I follow. The current yield for the company is 4.34%. It's triple-B rated, sports a "Very Safe" dividend, an earnings yield of nearly 12%, a low payout of 37%, and a 3-year forward PEG ratio based on current estimates of 1.31. Potential returns here still come to 10-16% on an annual return basis, with a respectably high yet well-covered payout.
Eastman simply remains one of my favorite investments in the sector, and I choose it before anything else due to the current upside, yield, and forward prospects. Honorable mentions go to Nucor (NUE) and Celanese (CE), both of which are excellent, but lower in terms of potential upside as I see it.
If you want Basic materials, I'd go with Eastman.
Picking the better stock in Communications is far harder, though, in the end, it does come down to mathematics and recent news. Two days ago, Omnicom Group (OMC) made it clear that it has no intention of changing the dividend policy, thus justifying its "Very Safe" rating once again and its Class 1 status. At a 38% undervaluation from my consideration of fair value, the company still yields 4.5%, BBB+rated, with only a 43% LTM payout ratio and a 10.4% earnings yield. The forward PEG ratio for the average coming 3-year forecasts, even with corona, is still 1.98. Comcast (CMCSA) is slightly better in that part of it, but yield, dividend streak, and other things speak in favor for Omnicom. The potential annual returns at this stage range from 14-22% annually if a return to normal valuation happens.
I love Comcast, and I love many other communications-based dividend stocks, but this is about picking one. Omnicom is safer and with more inherent upside to its current price as well as the higher well-covered yield - as such, it's my choice here.
No first-class stock in Consumer Discretionary is on sale. We must delve deeper, and find our appliance favorite Whirlpool (WHR) in Class 2. One might think I'd get tired of banging on about this 30% undervalued appliance giant yielding nearly 4.2% with a BBB credit rating, but I don't.
I want more, and I think you should too. 13.9% earnings yield, a 30% LTM payout ratio, and high 11% 5-year average dividend growth are only accentuated by the 3-year average forecast PEG ratio of 1.2X. While an honorable mention goes to its class-2 peer Leggett & Platt (LEG) for a higher dividend streak, the fact is Whirlpool is the better pick here at current valuation. Unless your portfolio is up to the gills in Whirlpool, this would be my choice for the sector. Upside is, even today, at 25% annually even based on just a return to normal valuation.
Consumer Staples is an easy pick as far as valuation goes. The fact is that unless you're willing to pay a slight premium for stocks like Lowe's (LOW), only Archer-Daniels-Midland (ADM) still shows an undervaluation in the Class-1 tier. For yield-chasers, Philip Morris International (PM) and Altria (MO) are also appealingly priced, but there can be only one per sector - and my current choice is for the lower-yielding farming giant ADM.
At 3.85% yield at an EPS yield of 7%, it may not sound that appealing, but the upside going forward is absolutely massive, with a current 3-year forward PEG ratio of 0.78X. At 44 years of dividends and a 54% payout ratio, you hardly need to worry about the dividend, and I believe that a grain company has a higher potential medium-term upside than companies peddling tobacco at this time. The fact is that the company is slated to grow nearly 12.31% in terms of earnings going forward annually, and while there's coin-flip-like accuracy to FactSet analysts here, I believe the trajectory at the very least to be accurate.
I can see the appeal of higher-yielding stocks here, especially with the quality of the two mentioned, but my choice still lands on ADM at this time.
Perhaps one of the harder sectors to choose in was Financials. Two companies are extremely attractive, but in the end, I do need to stick to my rules. Ameriprise Financial (AMP) is both twice as undervalued as I see things, and with a dividend safety and payout bordering on ridiculous at 23.88% of LTM EPS. No, the company doesn't have the highest yield compared to class 2 stocks like Toronto-Dominion (TD) or Principal Financial Group (PFG) - however, in the end, it has a potential upper-end upside of nearly 35% annually for the coming years, even at this point.
The company is A-rated, and even with its slight recovery, the valuation is still at an earnings yield of 14%, and with a dividend growth record of an 11% average over a 5-year period, the only actual downside to Ameriprise is its 14-year dividend streak - on the low side for an A-grade company.
I can see why some would consider Toronto-Dominion the "better" investment even now - but the fact is, the company no longer holds that spectacular undervaluation at "only" 28% compared to AMP's 53%. The potential upside based on simple, fair value is simply double as high in AMP as TD.
That is why in the end, I believe, AMP to be the financial-sector investment you want to consider at this time.
Moving on to Information Technology/Semis we find a bit harder choice. The fact is that the most undervalued A-grade company, Oracle (ORCL) has "only" a limited conservative potential upside of 5-10% over the next few years based on current estimates. It's a great company with an A+ rating, a competitive 7.4% earnings yield at current estimates, and a 25% payout ratio. The low limited upside combined with the modest dividend streak of 10 years makes the current potential returns somewhat lackluster when compared to Broadcom (AVGO), a class-2 stock.
However, Broadcom's credit rating is BBB-, its streak isn't all that impressive either, and the dividend is one notch less "safe"-considered than Oracle. All things considered, I do need to stick to the method here - Oracle is clearly the better choice for the very long term as I see things, even if growth and dividends may be more modest compared to Broadcom at this time. However, safety is tenet number one, and Broadcom's dividend stands at a 60%+ payout ratio on an LTM basis.
Both companies are excellent - and in pure financial terms, my Broadcom stake is larger, but it was also bought cheaper than the company is today. My current choice is Oracle.
Picking only one Industrial company may be considered tricky, but the fact is that there is a company that still stands out above all others in the A-list - and that company is General Dynamics (GD). With its A+ credit rating, safe dividend, Barely 37% LTM dividend payout, an earnings yield of over 9% for a company which trades at a forward PEG of 1.45, holding a wide moat and surviving both the dot-com bubble and the financial crisis without cutting the dividend... there is no peer in the first class at a better valuation, as I see it. Granted, you're not getting a 4% yield any longer - but 3.37% is still more than excellent for this company, as I see it.
Industrial peer Snap-on Incorporated (SNA) is also undervalued to similar degrees, but when comparing the two, the appeal of the overall fundamentals of GD can't be beaten even by Snap-on at this time. My choice, at a 34% undervaluation, is still General Dynamics - and I believe yours should be as well. The fact that we're looking at potential annual returns of 22% based simply on a return to normal valuation should knock your socks off when it comes to a quality company like this.
Real Estate is actually pretty easy. While there are some excellent companies out there, no real estate or REIT combines the two qualities of "quality" with "undervaluation/opportunity" as well as the Federal Realty Investment Trust (FRT). Sure, Realty Income Corporation (O) is also there, and we can always mention and love Simon Properties Group (SPG) at a 132% undervaluation. However, in the end FRT combines a 62% undervaluation with a 5% dividend yield, A- credit rating, 7% earnings/ocf yield, and a very safe dividend rating. The company sports my watchlist's only "king" in terms of dividend streak, with a 52-year streak, which I highly doubt will be put in jeopardy even by current corona troubles.
Basing forecasts on historical premiums rather than fair value is of course always a risk, but with FRT I believe this is at least somewhat warranted, indicating a long-term relatively safe upside of 20-22% annually, merely if it returns to normal value once things open back up.
While Realty Income could be a contender, the fact is that FRT is far more undervalued at this time - and I consider it to be unfairly so. FRT is my choice here.
In Utilities, no A-class stock is currently for sale or undervalued, with the highest appeal being found in Consolidated Edison (ED) at what I consider an 11% overvaluation. Instead, we need to go down into class 2 to find Dominion Energy (D). I consider the company around 9% undervalued, and with a 4.9% yield and a BBB+ credit rating, it can still be considered very safe and excellent. It's doubtful that corona effects against these businesses will be long, making them excellent investment targets for these somewhat troubled times.
I see Dominion as the natural choice here even compared to international peers, given its 30-year streak, Wide moat and excellent management. While its payout ratio is a little high at 88% and the earnings yield comes to about 5-6%, making it just enough to be interesting, the fact is that this is a very conservative and stable business over time. My goal is to extend my utility investments going forward, and my current recipe for doing this is investing in Dominion energy. At 5-12% potential upside at current levels in the long term, it's not a market-beating payoff that's guaranteed, but that, as I see it, isn't the goal when investing in quality-utility stocks compared to the conservative safety found there.
My choice here is Dominion.
Lastly, we have the Healthcare/Pharmaceutical Segment. There are some excellent companies on sale here, and this is the singular segment where I choose a Class 2 company over Class 1. Bristol-Myers Squibb (BMY) remains my choice here despite AmerisourceBergen (ABC) being technically a Class 1, very safe stock. However, BMY's upside following the Celgene M&A is absolutely massive even with conservative estimates. The company has an A+ credit rating, yields a 7.7% earnings yield at current valuations, and gives us a 3% dividend. A 30-year streak combined with a moat considered "Wide" by M* paints a picture that, following due diligence, can be somewhat confirmed going forward. Perhaps more interestingly, and to the point, BMY currently trades at a 0.56 3-Y average PEG ratio based on growth estimates, compared to 1.49 for ABC.
Both companies are on sale, but I consider BMY to be undervalued 57% at the current price - and that's where it is enough, given its A+ credit rating, that I can justify going into a second-class stock before one I would consider "First Class." You wouldn't be wrong to pick ABC here, of course, but I would say you're missing out on a likely double-digit total return opportunity over multiple years, with conservative estimates going as high as 30-40% annually.
My choice here, despite its Class 2 status, is Bristol-Myers Squibb.
Wrapping up
These are the choices that I, based on my way of evaluating stocks, would consider to be the current prime candidates for investment in the beginning of May of 2020. As I'm writing this article, we're looking at the markets opening in the negatives due to saber-rattling in terms of coronavirus blame. There are of course things that could cause us to drop back down 1-6% overall, and that is naturally one of them. I personally hope that this negative trend picks up steam, so that perhaps we may see companies that were at excellent valuation weeks ago see such valuations again.
However, even if that should prove not to be the case, the above-mentioned companies show enough undervaluation to be attractive without such a drop. There is always something on sale or buyable, and we happen to be lucky enough to invest in times where we can buy excellent businesses such as the ones mentioned here, at multi-year lows.
It's a great time to begin the building of a life-long financial safety - and the crucial thing, therefore, becomes to pick quality businesses that will not only resist troubles but may even, in the end, thrive due to trouble.
I'll post a few more articles going forward on stocks which are outside of the US and found at a current undervaluation. However, as these are currently slashing their dividends, and frankly aren't as appealing according to my method of viewing things, my current initial focus is still on the most qualitative businesses as I see things - these happen to be NA-based.
I tend to do most of my weekly buys on Fridays. My buys for this week are going to be found in the companies mentioned above, and little else. I believe eating your own cooking and having skin in the game is crucial - I follow the advice I write about, and I take the investment stances I recommend others do, regardless of their financial situation.
Quality, dividends, and positive diversification above all, as these qualities bring us long-term investment safety and crucial ability to sleep safely at night, regardless of what the market is doing that day - or that year.
Thank you for reading.
This article was written by
Wolf Report is a senior analyst and private portfolio manager with over 10 years generating value ideas in European and North American markets.
He is a contributing author for the investing group iREIT on Alpha where in addition to the U.S. market, he covers the markets of Scandinavia, Germany, France, UK, Italy, Spain, Portugal and Eastern Europe in search of reasonably valued stock ideas. Learn more.Analyst’s Disclosure: I am/we are long ADM, AMP, CE, CMCSA, D, FRT, GD, JNJ, KO, LEG, LOW, MO, NUE, OMC, PFG, PM, TD, WHR, ORCL, ABC, BMY, AVGO, O, SPG. 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.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (27)
Thank you und keep up the great work.
Only own 3 of them at this time. Avg. div.= 3.85%
Expecting a downturn, then enter gradual buying. The average dividend could be 4% at that point.
AMP is heavily undervalued, more than BX. First AMP, then BX. But preferably both. Not a duty for me. Significantly more fun.
However, what about the energy sector? Thank you!
High praise - thank you! :)
Thanks for the compliment! I try not to overcomplicate and include too much in terms of detailed analysis. if you're interested in more deep dives into financials, most of these companies have that in several articles :).All the best!
Thanks, love that you read and comment :).