By Bob Ciura with Sure Dividend.
The U.S. stock market has come roaring back from the lows seen in March and April, but the broader economy remains on unstable footing. The potential for a double-dip recession could bring about another downturn in the stock market. For risk-averse investors, it may make sense to buy high-quality dividend stocks in this climate of uncertainty.
For this reason, we recommend income investors looking for stability, consider the Dividend Aristocrats. This is an exclusive list of 65 stocks in the S&P 500 Index, that have raised their dividends for at least 25 consecutive years. Such a long track record of annual dividend increases proves a company’s ability to withstand recessions.
The following three stocks are all on the list of Dividend Aristocrats. In addition, they have high dividend yields well above the S&P 500 average, as well as reasonable valuations that could provide investors with high total returns in the years ahead.
Undervalued Dividend Aristocrat #1: AbbVie
AbbVie Inc. (NYSE: ABBV) is a healthcare giant with a focus on pharmaceuticals. Its most important individual product is Humira, a multi-purpose pharmaceutical that was the top-selling drug in the world last year. AbbVie was spun off from Abbott Laboratories (ABT), its former parent company which is also a Dividend Aristocrat. AbbVie has performed very well over the course of 2020.
In the third quarter, AbbVie’s revenue of $12.9 billion increased 52% year-over-year. Revenue was boosted by the Allergan acquisition, as well as growth from new products. AbbVie earned $2.83 per share during the third quarter, up 21% from the previous year’s quarter. The company also raised full-year guidance and now expects 2020 adjusted earnings-per-share in a range of $10.47 to $10.49, which would make for another year of growth.
AbbVie also raised its dividend by 10% in late October. The stock has a high dividend yield of 5.3%, making it an attractive mix of yield and growth. AbbVie stock also appears to be undervalued, trading for a price-to-earnings ratio of 9.4, using the midpoint of full-year adjusted EPS guidance. This is a fairly low multiple for a highly profitable and growing business.
AbbVie’s low valuation is likely due to uncertainty regarding its flagship product Humira, which is now facing biosimilar competition in Europe and will lose patent protection in the U.S. in 2023. But AbbVie has long prepared for this by investing in its own new products, and by the Allergan acquisition. For example, AbbVie has seen strong growth from Imbruvica, which saw a 9% increase in sales last quarter. AbbVie also completed the $63 billion acquisition of Allergan which makes a broad line of popular aesthetics products such as Botox.
Our fair value estimate for AbbVie stock is a P/E of 10.5, compared with a forward P/E of 8.4. This means that if AbbVie’s valuation expanded from 8.4 to 10.5 over the next five years, total returns (including EPS growth and dividends) could exceed 10% per year.
Undervalued Dividend Aristocrat #2: Walgreens Boots Alliance
Walgreens Boots Alliance (NYSE: WBA) is a major pharmacy retailer with nearly 19,000 stores in 11 countries. Walgreens Boots Alliance generates nearly $140 billion in annual revenue. Walgreens has been under pressure on many fronts, not just the coronavirus pandemic but also from a longer-running downturn for physical retail.
Internet-based retailers such as Amazon.com Inc (NASDAQ: AMZN) and many others have gradually taken market share from physical stores, as consumers have gravitated toward online shopping for the convenience. This trend was already taking place heading into 2020, and the coronavirus has only accelerated the shift to online shopping. Still, Walgreens remains highly profitable and continues to grow sales.
On October 15th, 2020 Walgreens reported Q4 and full-year 2020 results for the period ending August 31st, 2020. For the quarter, sales increased 2.3% to $34.7 billion. On a per-share basis, adjusted EPS decreased -28.2% to $1.02, reflecting an estimated adverse impact of -$0.46 from the COVID-19 pandemic.
For the fiscal year, sales increased 2.0% to $139.5 billion. Adjusted earnings-per-share totaled $4.74, down 21% year-over-year but ahead of previous guidance of $4.65 to $4.70. This included an estimated -$1.06 adverse impact from the COVID-19 pandemic. The company anticipates a recovery in the upcoming year, with fiscal 2021 guidance that calls for low single-digit growth in adjusted EPS.
Continuing to grow sales and earnings, albeit at a modest rate, would still allow Walgreens to increase its dividend each year, as it has done for 45 consecutive years. Shares yield 4.5% currently, and the stock appears to be undervalued. With a forward P/E ratio of 7.9 compared with our fair value estimate of 10, we believe Walgreens stock can provide total returns of 13%-14% per year over the next five years.
Undervalued Dividend Aristocrat #3: AT&T
AT&T Inc (NYSE: T) is a telecommunications giant with a large offering of services including wireless, broadband, and pay TV. AT&T also operates the satellite television business DirecTV. The company has invested heavily to restore growth in recent years, including the massive ~$85 billion acquisition of Time Warner, which owns multiple valuable media properties including HBO, CNN, and the Warner Bros. production company.
These efforts have been slow to materialize, as the coronavirus pandemic has negatively impacted AT&T to start 2020. Still, AT&T generates a high level of cash flow, which allows it to pay down debt and pay dividends to shareholders. In the 2020 third quarter, AT&T generated revenue of $42.3 billion, along with operating cash flow of $12.1 billion. The company recorded more than 5 million total domestic wireless net adds along with over 1 million postpaid net additions.
AT&T’s acquisition of Time Warner should pay off in the long run, as it provides AT&T with valuable diversification. Going forward, AT&T will be an owner of content in addition to a distributor, which is increasingly important in the era of streaming and cord-cutting. Another promising growth catalyst is 5G rollout. AT&T now provides access to 5G to parts of over 350 U.S. markets.
AT&T still expects free cash flow of at least $26 billion for the full year. AT&T’s net debt-to-EBITDA ratio was ~2.66x at the end of the quarter, indicating a manageable level of debt. This is crucial for AT&T’s ability to pay its dividend, which is presumably the biggest reason to own the stock. AT&T currently yields 7.3%, an extremely high yield considering the S&P 500 average yield is under 2%. In an environment of low interest rates, AT&T is a highly appealing stock for value investors. Plus, AT&T has increased its dividend for over 30 years in a row.
The stock is also significantly undervalued in our view, trading at a forward P/E ratio of 8.9 compared with our fair value estimate of 11. This means valuation expansion could boost future shareholder returns by approximately 4.6% per year over the next five years. Including the 7.3% dividend yield and 3% expected annual earnings-per-share growth, expected returns could reach nearly 15% over the next five years.
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