Build This $95,000, 20% Undervalued Income Machine With 5% Yield
- In this article, I'm going to address one of the more common questions or comments I get messaged into my inbox.
- People seemingly have capital but are at a loss as to how to invest their money in the current climate.
- I will show you a portfolio that despite overvaluation, will generate at least 5% yield with realistic DGR, and a 20% valuation upside from today's valuation.
- Let's go, and enjoy my picks!
One of the more common questions I get these days, which is understandable, given the current rate of overvaluation in the market not seen since the dot-com bubble...
(Source: S&P Global)
...is what the heck investors should buy today, given this rate of valuation and the sub-par return expectations this creates for most companies.
Make no mistake.
Most companies are overvalued here. That doesn't mean, however, that you can't build an undervalued dividend portfolio. We just have to be a lot more careful and circumspect, unlike over a year ago, when you could throw a rock and hit an undervalued company without much trouble.
In this article, I'm going to build a fictional portfolio with the following goals, that's based on my own DGR portfolio, with a current value of around $1.28M, yielding 4.2%.
- $95,000 in invested cash
- No more than 5.5% in any one company.
- A Yield on Cost of 4.5-5%.
- An average of 15-20% in realistic conservative, 3-4 year upside for every single company therein.
- Both US and international stocks.
- As good a sector diversification as we can manage given the current circumstances.
- Every single company I pick will be a company I have in my own, $1.28M DGR portfolio. I will not pick a company I haven't invested in.
- Every single company will be investment-grade credit-rated.
I don't claim that I'll be able to pick 50 stocks that fulfill these criteria - because to tell you the truth, that won't be possible. What we'll instead be doing is a concentrated, 10-20 stock portfolio of the best companies currently available at cheap prices.
It will be a worthy beginning, or addition, to any dividend investor worth his/her salt today.
Let's not waste time, but get going.
We're storming out the gate with investments in Telecommunications. Specifically, we're going Telenor (OTCPK:TELNF), Orange (ORAN) and AT&T (T).
1. Telenor is the Norway-based, Scandinavian Telco that currently has a yield of 5.77%, at a native price of 154 NOK/share. The average 1-year price target for this company is between 165-170 NOK and given an expected EPS improvement of 127% on a GAAP basis in 2022, or an average EPS growth rate of around 10% for the past 5 years, adding the dividend to this gives us our desired 15-20% upside. While this one may certainly not be everyone's first choice, I've written multiple articles on why this company is amongst the best of its breed in Scandinavia, the latest article being found here.
My own portfolio stake in Telenor is 3%.
2. Orange is another pick that might leave a few head scratchings, but I will tell you very clearly that this is a 7-8%-yielding France telco giant, BBB+ rated with a superb upside. There certainly is a bit of risk here, but that risk is not existential - it's transitory, until which time the company will still pay its hefty dividend. Even on a 11X P/E basis, currently 7.26X, the company yields 77% in 4 years, coming to 18.24% CAGR. On a fair-value 15X P/E, this explodes to 25% or 114% in 4 years. The company traded at such levels less than 2 years ago.
(Source: F.A.S.T Graphs)
Current S&P global analysts' targets call for a 30% upside for ORAN in the long run. I view it as a "BUY". My own portfolio stake in Orange is 1.3%.
3. AT&T is a third company that might cause people to waver. After all, we're looking at a potential dividend cut. It took a bit of consideration including this, but the fact is when people look at Telco's, they too often focus on transitory, cyclical risks and ignore the through-cyclic assets and incomes that are the reasons for the companies' 4-7% yields, and will continue, barring a complete breakdown. AT&T isn't going anywhere, and while I'm keeping the position limited here, I still think its 15% CAGR upside to a 2024E of 11.2X P/E is fair and conservative - and even a reduced yield will serve to reward shareholders decently.
AT&T has a current conservative upside of S&P Global targets of $32/share, which combines a 12% valuation upside with a 4-7% yield on the current share price. AT&T, on this basis, is a "BUY", and I include it in this portfolio.
We move from Telecommunications into Consumer Staples. Our main picks here are going to be Tobacco and Chicken as well as some other things.
My stake in AT&T is 1.2% of my portfolio.
4. Altria (MO)
I recently wrote how you can argue with tobacco, but you can't argue with the mathematical, financial results that the companies get. Altria is one of these companies, currently trading at a substantial, 20% upside to a fair, conservative valuation of 15X given its earnings growth of 4-5% and well-covered yield of 7.2%.
(Source: F.A.S.T Graphs)
Altria doesn't miss forecasts. It doesn't provide poor earnings. It survives every tobacco downturn and adapts, already adapting to heated as opposed to traditional tobacco. It is a solid business and will provide you with dividends for years to come, as well as growth if you let it.
It's a must-own part of this fictional portfolio.
My stake in Altria is 1.7% of my portfolio.
5. British American Tobacco (BTI) is a solid business with very similar fundamentals, a smidgen higher volatility, but a better credit rating. It also offers a nearly 8% yield, a yield that's very well-covered. It has a very similar, but even better current upside to a fair-value 13.3X in 2024E, of 27% CAGR. Based on these numbers alone, as well as earnings trends forecasting average EPS growth of 5%, this one is a "BUY".
BTI has a solid upside from every vantage point, even a completely flat valuation trend until 2024. The S&P global target for the company is a $52.04, giving us a valuation upside of 37%.
I own 1.89% of British American Tobacco exposure in my core portfolio.
6. Tyson Foods (TSN) is one of the world's foremost meat suppliers, especially chicken and pork. This is a segment that's a bit more volatile than what we've been looking at, but this is a solid, BBB+ rated company with a combined growth/reversal upside of 18% at current levels. The company, despite its fundamentals and market position trades at 11.73X P/E, or 8.52% EPS yield, which gives us the following 2023E.
(Source: F.A.S.T Graphs)
Similarly, the upside for the company according to S&P global forecasts, is 16% undervaluation, which together with the yield comes to almost 18-20%. Exactly what we're looking for, even if this is not exactly the highest yielder we could buy.
Still, I consider this a solid "BUY" here. Tyson Foods makes up 0.3% of my portfolio at this time.
7. Walgreens (WBA) is another company that some people won't like. The risk from Amazon (NASDAQ:AMZN), what if this happens, etc., etc. The fact remains that WBA operates one of the largest pharma/convenience networks in the entire US and owns a huge part of the scrip market. None of these advantages are going away because of "Amazon". The company is currently being traded just at 10X P/E, which for a company growing EPS at 4-5% for the next few years is too low. It also yields over 4%.
(Source: F.A.S.T. Graphs)
The market can bicker and talk risks, but in the end, it won't be arguing with mathematics. I believe Walgreens will see strong reversion if it maintains these earnings, and that combined reversion and yield will result in returns of 26% CAGR over the next 2-3 years. It's the simplest of valuation theses. I believe Walgreens' cash flows are worth more than the market is valuing them. Hence, I buy WBA.
S&P global is granting WBA a target of $83, indicating an upside of 16.6%. I own around 1.1% of my portfolio in WBA.
Now, leaving Consumer Staples behind with 4 choices in the bag, we turn our attention to the financial sector, where we can find a few very good upsides.
8. Unum Group (UNM) is the stock we begin with, a very good company in the insurance sector, one that recently bumped its targets, but refuses to climb in valuation - a great thing. I recently bumped my stake in this company, and consider it, together with my next pick, to be one of the best picks in the finance sector today. The company, at today's price, and based on an estimated valuation of only 7.5X P/E, has an upside of well over 30%, yielding 4.8%. It's estimated to grow earnings by 5% per year on average until 2023, so the upside and potential returns for shareholders are extremely positive. Analysts offer this company a target of $30/share, which even as conservative as this, gives us an upside of over 15%. I recently wrote an article on the company which takes a deeper look at the potential performance and risk.
Unum is a "BUY", and I own around 1.05% of my portfolio in Unum stock.
9. Reinsurance Group of America (RGA) is my second pick here, and a good one as well. While this company has a longer recovery time, at least as I see it, the eventual EPS reversion will make certain that investors don't go unrewarded from this opportunity. This is a company I mean to buy more of.
Current analyst targets for this company are up to $130/share, giving us a firm upside of 15-17% even without the dividend here. I consider RGA to be a firm "BUY", and I own a 0.6% stake in my portfolio in RGA.
We, unfortunately, have to leave financials behind, as there aren't any other stocks in the sector that I follow that meet the targets of the fictional portfolio I'm trying to build here. IT/Semi's/Software is another sector we'll completely gloss over because again, there aren't any interesting or appealing companies available to buy here that meet my targets. I know of a few undervalued ones, but they don't meet the goal of being in my portfolio - and I want to only recommend companies that I actually own.
So, Industrials is the next sector. Pickings here are very slim indeed, but they do exist. First, since the recent set of dips, we have number 10.
10. Lockheed Martin (LMT) isn't as good as it was when I bought below $325/share, but at current levels, it's still where I would consider it decent enough. Until 2023E results, it has an upside of around 18.3%, including a dividend yield of 2.81%.
Even though it's not an amazing price, the growth we're looking at is indeed amazing, and I consider it both realistic and conservative enough for an investment thesis to be valid. Current price targets call for a price of $426, which indicates an upside of around 15%. Good enough for me for investing.
I own 1.45% of my portfolio in Lockheed Martin.
11. L3Harris Technologies (LHX) means we're going from Aerospace & Defense to Aerospace & Defense. This company was the absolute last addition to my defense portion of the portfolio, where I essentially invested $12,000 in the space of several days as the company was undervalued. I have been handsomely rewarded for my recognition of this undervaluation, with 25.4% total RoR, or 71.2% annualized since my purchase. However, the company has not finished growing.
(Source: F.A.S.T graphs)
Based on growth and reversion, your returns could be 16-17% for this defense company with a BBB rating, if you invested today. The yield isn't that great, but the upside and the backlog make up for it. This, I believe, is an excellent investment.
1.35% of my portfolio is L3Harris Technologies.
We now move from Industrials into Pharma - and we'll stay there for quite a bit.
12. Bristol-Myers Squibb (BMY) is a company you should know that I would include here. It's the best upside in all of Pharma to me, with at the very least a 22% 4-year CAGR upside, coming to almost 100% returns in less than 4 years.
(Source: F.A.S.T Graphs)
It's A+ rated, extremely safe dividend, still yielding nearly 2.9%, and with superb outlooks. It's going to take some time for the company to revert - no doubt about that. But until then, your money is, I believe, quite safe. BMY is most certainly a good stock for your portfolio here.
2.88% of my portfolio is BMY.
13. We move to Merck (MRK), another good buy but with more of a growth upside than a reversal one. It's not as cheap as it was, unfortunately, but it also doesn't miss forecasts, it's A+ rated, and you could make a CAGR of 16-17% until 2024 based only on a fair-value 15X P/E.
(Source: F.A.S.T Graphs)
The company offers impressive forecasts (which it historically has always met), a great yield of nearly 3.5%, which is extremely well covered, low debt, and just one of the largest pharma businesses in the world at a damn cheap price for where the stock is going. In some sectors, a stock like this had traded at 30X P/E, not 13.5X.
I consider it a "BUY" and I have 2.6% of my portfolio in Merck.
14. Takes us into heavy value and reversal territory, and we look at Bayer (OTCPK:BAYZF). Again, one of the largest pharma businesses in the world, with forays into animal health and other things, but currently heavily discounted to perceived legal risks and potential headwinds. I'm not saying earnings will go to the moon - I'm saying it's a damn solid business with BBB credit rating trading at a cheap valuation, offering a 2024E upside of nearly 100% and a CAGR of 22%. It's under €50/share, which is when I loaded up the truck for my portfolio, recently buying more at a yield of over 4%.
No doubt it could take a while for things to revert here - but I'm fine with that. Gives me more opportunity to build my position. It's a great company, at a great price. "BUY" it, that's my stance. I currently have 0.7% Bayer in my portfolio.
15. Fresenius (OTCPK:FSNUY), means we're staying in Germany for the time being. I've written several articles on this company, showcasing what I believe to be a substantial upside for the coming years due to growth and reversal in a company with an appealing business mix and a very decent moat in many of its businesses. It's BBB rated and yields around 2.62%.
(Source: F.A.S.T Graphs)
The upside to a slight premium of 18%, given the expected EPS growth of nearly 8% p.a., is nearly 20% CAGR until 2024, meaning it fulfills the criteria for investing in this portfolio.
I have 1.1% Fresenius in my portfolio.
16. Then we have Cardinal Health (CAH). The company isn't a margin monster, but it's a solid business with excellent numbers and some decent upside. You, unfortunately, won't see the performance I've seen - it's too late for that - but a 10.3% earnings yield/9.8X P/E company that should trade closer to 13-15X still can give you a 3-year upside of nearly 20% CAGR at a forward valuation of 12X P/E.
It's IG-rated, yielding 3.3% here, and one I consider a very stable investment indeed. Even looking at conservative price targets, this company has a significant upside, and management takes good care of business. I've owned my significant stake for over a year now, and should the company not climb back up, I might add more.
I own 1.6% Cardinal Health in my core portfolio.
17. Finally, with the last pharma stock of the bunch, we have AbbVie (ABBV). While this company suffers from a bit of overexposure to Humira, its absolutely solid business including the drug will last until patent expiration, at which point it's becoming more and more clear that the company can handle most of the drop-off with no great issue. The company still trades only at a 9.7X P/E and is BBB+ rated. It's a superb business spun off from Abbott Labs, and I've invested heavily in AbbVie since its bottom undervaluation 1 year and 2 years ago. It still yields 4.52% (my own YoC is well over 6.2%), which is outsized for the sector, and despite the expected EPS growth dropoff in 2023, I see this company as safe. On a 2024E basis with average EPS growth of 4.2%, including the Humira dropoff, you're looking at 15X P/E returns of 17-18% CAGR including dividends.
AbbVie is an excellent company at a good price. I'm including it, and 1.3% of my portfolio is in AbbVie.
The last two positions are companies we find in the Energy/Midstream sector. You may exclude these, if you like, to get the portfolio to an $85,000 size yielding 4.7% instead of 5%, if you don't like Oil/Energy.
Me, I believe my two picks represent very safe investments with well-covered dividends and excellent cash flows.
18. First, we have Enterprise Products Partners (EPD), undervalued even more following the latest quarterly. The company covers its distribution on a 60% payout basis and following the recent drop-off, has an upside to 2023 of almost 26.5% to a 10.5X P/OCF or FFO. That's an excellent set of numbers. EPS is BBB+ rated with superb safeties, and even if you're a green investor, you must realize that oil, natgas and similar products transported by the company will be needed for a minimum of 40-80 years.
(Source: F.A.S.T graphs)
EPD is most certainly a "BUY" here, and I own 0.7% EPD in my portfolio, with the intention of expanding that to around 1.12%.
19. Second, and last in this article, we have the income coming from Pembina Pipeline (PBA). The company is BBB rated as well, and until 2023, the P/OFC multiple of around 11-12X gives us an upside of 19% CAGR with a current yield of 6.12%. It's true that the company has reverted somewhat already, but to my mind, there's plenty of room for more reversal here.
Pembina Pipeline is a great company with an amply-covered dividend payout. It only represents 0.3% of my portfolio at this particular time, but it's a company I mean to push more cash into. The upside and safeties are too appealing to ignore.
(Source: F.A.S.T graphs)
These 19 companies, invested at $5000 each, give us the following hypothetical investment portfolio.
|British American Tobacco||$5,000.00||$400.00||5.26%|
|Reinsurance Group of America||$5,000.00||$140.00||5.26%|
|Enterprise Products Partners||$5,000.00||$400.00||5.26%|
The total investment amount is $95,000. It could also be $9,500 or $95,000 000, depending on your circumstances. The dividends here are $4,775, which brings us to an average weighted yield of ~5.026%.
- All of these companies are undervalued.
- All of them have 15-20% realistic, conservative upsides on current valuation levels.
- All of them are at least BBB rated.
- None of these is any sort of nanocap, microcap, unknown company, growth stock with no dividend, elevated risk stock, or anything like that.
- I own stock in all of these companies, with total skin in the game of well over $150,000.
These are quality companies buyable at discount prices, and they will provide you with dividends for the foreseeable future.
Do you want a more conservative, defensive portfolio?
Just bump your exposure in some of the more conservative stocks, or remove higher-risk stocks like oil/energy or pharma.
Do you want a higher-yielding portfolio?
Just bump your exposure in tobacco, oil, and telecommunications, while lowering in the defensive sectors.
I see very little reason to foray into riskier sectors for yield-hunting when you're able to get these superb yields and returns from safe, investment-rated companies on the market today.
When I invest today, these are the companies I look at. These types of companies are what I want.
They do change over time. In 2 weeks, some may no longer be all that buyable, or new ones may have appeared.
But these are buyable now.
Questions or comments?
Please let me know.
This article was written by
Mid-thirties DGI investor/senior analyst in private portfolio management/wealth management for a select number of clients. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.
I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ALL STOCKS MENTIONED either through stock ownership, options, or other derivatives. 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. Short-term trading, options trading/investment and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
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