Dividend investing is one of the most popular themes among investors -- and rightfully so.
Multiple studies have confirmed the market-busting returns of dividend stocks. Ned Davis Research found that over the four decades through 2014, dividend-paying stocks returned 7.6% on an annualized basis versus just 2.6% from stocks that paid no dividend.
And that's just the companies that kept their payouts consistent. Companies that regularly increased their dividend payouts returned 10.1% annually.
But historically-low interest rates have forced investors out of bonds and into dividend stocks for yield. Valuations look stretched and the U.S. economy just recorded its slowest growth in three years.
While there's no reason to believe that dividend stocks won't continue to outperform the market going forward, investors can't ignore record-high valuations after eight years of surging stock prices. It does little good to grab a hefty 3% dividend if valuations collapse and prices fall 10% or more.
But look close enough and you can still find a few strong dividend stocks in value territory.
How To Find Great Dividend-Payers On The Cheap
Looking for value stocks is more than just sorting for the lowest price-to-earnings ratios. In a market where investor enthusiasm has pushed almost all stocks higher, value stocks may be cheap for a reason.
Avoiding the proverbial falling knife means looking deeper into a company's fundamentals.
I started my cheap dividend search by screening for yields over 3% and stocks with valuations below their industry average according to Morningstar. I also checked the company's current price-to-earnings against its five-year average.
Remember, the price-earnings ratio is a relative measure and can only tell you if a stock is less expensive versus the same valuation for another stock or an average. It's a good place to start, but finding real value means taking a closer look at a company's financial statements.
The first place I look in a company's financials is the company's debt-to-equity ratio. This is hugely important for value stocks, especially when the rest of the market is trading higher.
Even the best companies can have a couple of tough quarters and see their stock price crumble into value territory. Companies with some flexibility in their balance sheet can retrench and bounce back stronger than ever. Companies with high debt burdens, usually put on after years of an aggressive acquisition strategy, may not have the flexibility to survive.
Compare the company's debt-to-equity against the industry average and use the EBITDA-to-Interest coverage ratio to make sure it's booking enough income to cover interest payments.
I also look for dividend growth to confirm management's commitment to the cash payout. This tells me that the high dividend yield isn't just a function of a falling stock price but of an increasing dividend as well.
Finally, investing decisions have to be made with an eye to the future. Fundamentals on trailing financials can confirm valuation and management's ability but equity investing is all about future cash flows.
I want to see that the outlook will support the dividend with additional price appreciation.
Three Cheap Dividend Stocks For Your Portfolio
Finding quality dividend names in value territory is getting difficult and you need to be extremely critical of any stock trading for a steep discount to the rest of its industry. Just three companies passed my test for cheap dividend stocks based on the criteria above.
Altria Group (NYSE: MO) trades for a discount of 34% against the average P/E multiple of 14.9 times trailing earnings for its industry. Debt of 1.1 times equity is marginally lower than the average multiple of 1.25 times for tobacco producers.
Shares have been under pressure against a long-term decline in U.S. cigarette volumes which fell 2.5% last year. The company's Marlboro brand has been the market leader for more than three decades with 44% of the U.S. market. Government restrictions and a very mature industry protect Altria's leadership and the company's sales should be relatively strong versus its peers.
The maturity of the tobacco industry means Altria needs to spend very little on capital expenditures and can return nearly all its operational cash flow to investors. The company has diversified sales into smokeless products and wine, both of which are growing, and is expected to post 8.5% earnings growth to $3.29 per share this year.
Intel Corporation (Nasdaq: INTC) trades for a discount of 37% against the average P/E multiple of 27.8 times for its industry. Debt of 0.3 times equity is well under the average multiple of 0.45 times for semiconductor peers.
Intel dominates the microprocessor market with roughly 80% of the market share. Nearly twice the size of most peers, Intel spends nearly $10 billion a year in R&D to develop new technologies that will support its leadership. The cyclical nature of the semiconductor industry allows Intel to grab market share during periods of weakness while peers are forced to retrench to protect cash flow.
The company is expected to post earnings growth of 5.1% this year to $2.86 per share but has beaten estimates by an average of 6.8% over the last four quarters. Data center growth is picking up the slack for continued weakness in personal computers and the company has constantly proven its ability to shift with the dynamic landscape for tech needs.
General Motors (NYSE: GM) trades for less than half the average P/E ratio of 11 times for auto manufacturers. Debt is slightly higher than the 1.14 times equity average in the industry but the company easily covers interest and has a strong BBB- credit rating from Standard & Poor's.
Automakers have struggled this year as it looks like growth in car sales could cool from consecutive records over the last few years. General Motors has also been hit recently on the Supreme Court's denial for an appeal of circuit court ruling that opened the company up to lawsuits from owners of cars manufactured before its 2009 bankruptcy. Analysts have estimated the potential liability as high as $10 billion but it's likely the company will be able to settle claims for far less and any settlement news could spark a relief rally in the shares.
GM is only expected to post 1% earnings growth to $6.18 per share this year but has beaten estimates by an average of 16% over the last four quarters. Even as Tesla (Nasdaq: TSLA) steals the spotlight for automaker investors, GM's size gives it a huge cost advantage in the industry. The company is regaining lost brand strength after its 2014 problems with faulty ignitions and is my favorite cheap dividend stock.
Risks To Consider: Rising interest rates may draw investors out of dividends and into bonds, producing a headwind for dividend-payers. Look for best-of-breed names with growing dividend payments that can continue to draw investor interest.
Action To Take: These cheap dividend stocks can continue to increase cash payout while providing some of the last value plays in the market.
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