Once upon a time, high dividend stocks tended to trade at discounts to the rest of the market. Today? No such luck.
In a recent piece for his blog, “The Investor’s Field Guide”, Patrick O’Shaughnessy provided data showing that high dividend yield stocks did at one time enjoy a valuation advantage over other stocks. “[But] their valuation advantage has collapsed,” he wrote. Prior to 2009 – when the bear market bottomed – higher yielders (stocks with dividends over 4%) were cheaper than those with yield in the 2-4% range 92% of the time, O’Shaughnessy says. Since then, they’ve been cheaper just 30% of the time.
What gives? O’Shaughnessy offers a very plausible theory:
“This is impossible to confirm, but the easiest explanation is that investors (especially older ones) have needed more income in this low rate environment, and have bid up the valuations of high yielders.”
O’Shaughnessy also notes that the overall correlation between dividend yield and valuation has been declining for many years. This, he says, has implications for investors. With dividend yield itself no longer acting as a valuation tool, investors looking for high yielders must be careful to use other metrics to gauge value. I couldn’t agree more. Rushing blindly into high dividend stocks simply because they have a high yield is not good investing. Sometimes the dividend yield will be high because the price of the stock is very low, and low for good reason (i.e., the firm is a dog and its shares are going nowhere). And, after all, what’s the point of getting a high dividend payment if the stock costs you money by performing poorly?
So, if you’re going to look for income through stock dividends, you need to make sure that – as with any stock you buy – the stock’s fundamentals are strong and the company’s balance sheet is solid. With that in mind, I recently used my Guru Strategies (each of which is based on the approach of different investing greats) to find some stocks that not only have high dividend yields, but also have attractively priced shares and solid financials. I found a number of them that fit the bill and are good candidates not just for steady income but for capital appreciation as well.
Here are some of the best of the bunch.
Douglas Dynamics Inc
Wisconsin-based Douglas Dynamics Inc (NYSE:PLOW) makes vehicle attachments and equipment, such as snow and ice management attachments, turf care equipment, and industrial maintenance equipment. It currently offers a 4% dividend.
The model I base on the writings of hedge fund guru Joel Greenblatt is particularly high on Douglas ($450 million market cap). Greenblatt’s approach is a remarkably simple one that looks at just two variables: earnings yield and return on capital. My Greenblatt inspired model likes Douglas’ 10.9% earnings yield and 48.3% ROC.
Taiwan Semiconductor Mfg. Co. Ltd.
Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM) offers integrated circuits and other semiconductor devices. The $103 billion market cap firm currently offers a 3.6% dividend.
TSM gets high marks from the strategy I base on the writings of mutual fund legend Peter Lynch. The Lynch strategy considers it a “fast-grower” – Lynch’s favorite type of investment – thanks to its impressive 20% long-term EPS growth rate. (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate.) Lynch famously used the P/E-to-Growth ratio to find bargain priced growth stocks, and when we divide TSM’s 11.4 price/earnings ratio by that long-term growth rate, we get a PEG of 0.56. This model considers anything below 1.0 a bargain.
Lynch also liked conservatively financed firms, and the model I base on his writings targets companies with debt/equity ratios less than 80%. TSM’s D/E is 21%, another good sign.
Johnson & Johnson
Johnson & Johnson (NYSE:JNJ) offers a range of products in the health care field, with more than 265 operating companies conducting business around the world. It makes consumer healthcare/wellness products, pharmaceuticals and medical devices. The $260 billion market cap firm’s shares come with a 3.2% dividend yield.
My James O’Shaughnessy-based value stock model is high on JNJ. When looking for value plays, O’Shaughnessy targeted large firms with strong cash flows and high dividend yields. JNJ is plenty big enough, has $7.16 in cash flow per share (more than four times the market mean), and that solid 3.2% yield, all of which help it pass the O’Shaughnessy-based model.
Siliconware Precision Industries (ADR)
Siliconware Precision Industries (ADR) (NASDAQ:SPIL), a provider of semiconductor packaging and testing services, offers advanced packages, substrate packages and lead-frame packages, as well as testing for logic and mixed signal devices. The $4 billion market cap firm’s shares come with a 7.4% dividend yield.
My David Dreman-inspired contrarian approach thinks SPIL is a good contrarian bet. It considers it a contrarian play because its price/cash flow, price/earnings, and price/dividend ratios fall into the market’s cheapest 20%. Dreman realized that sometimes, however, a stock is cheap because everyone knows it’s a dog, so he also used an array of fundamental and financial tests. This model likes SPIL’s solid 18% return on equity, 17.6% pre-tax profit margins, and 41% debt/equity ratio, which is low for a semiconductor firm (the industry average is 108%).
Maiden Holdings, Ltd.
Maiden Holdings, Ltd. (NASDAQ:MHLD) serves regional and specialty insurers in the United States, Europe and select other global markets by providing reinsurance solutions designed to support their capital needs. It has a portfolio of property and casualty reinsurance businesses focusing on regional and specialty property and casualty insurance companies. Currently, its shares come with a 3.6% dividend.
Maiden ($1 billion market cap) gets high marks from the model I base on the writings of mutual fund legend John Neff. Neff focused on the P/E ratio, looking for stocks with P/Es between 60% and 80% of the market mean. (P/Es that were too low could be a sign the company was a dog, he found). Maiden’s 10.7 P/E makes the grade.
Neff also targeted firms with solid growth, but not spectacular growth – he found that firms with extremely high growth rates were often too pricey. The Neff-based model thus likes Maiden’s solid 14.5% long-term earnings per share growth rate and its 16.7% long-term sales growth rate. Finally, Neff was a big believer in the importance of dividends and he liked to use the total return/PE ratio, which combines a stock’s growth rate and dividend yield and divides it by its P/E ratio. Neff liked it when this figure was twice the market average or a stock’s industry average, and Maiden’s total return/PE of 1.69 is well over twice the market average of 0.6.
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