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3 Undervalued Stocks Offering 20%+ Potential Returns

GuruFocus.com
·7 min read

- By Nathan Parsh

With the major U.S. stock market indexes all at or near all-time highs, finding bargains in the market is difficult. However, there are some stocks still trading below their intrinsic values that pay a generous dividend yield and offer the potential for outsized gains, in my opinion.

In this article, we will examine three stocks with dividends yielding 3%+ that are trading below their GF Value line, a unique intrinsic value calculation from GuruFocus that you can read about here. By my estimations, these three names have the potential for total returns of at least 20%.


First Merchants Corporation

First Merchants Corporation (NASDAQ:FRME) is a financial holding company that offers a wide range of services, including savings accounts, personal and corporate trust services, full-service brokerage advice, private wealth management and consumer, commercial, agriculture and real estate mortgage loans. The bank has 125 offices in Illinois, Indiana, Michigan and Ohio. First Merchants Corporation has nearly $14 billion of assets. The bank has a market capitalization of $1.9 billion and has generated $484 million of revenue over the last four quarters.

First Merchants Corporation will distribute a $0.26 per share quarterly dividend to shareholders on Dec. 18 for shareholders of record at the close of business on Dec.4. The annualized dividend of $1.04 gives the stock a 3% dividend yield based on Friday's closing price of $34.71. This is more than a full percentage point better than the stock's five-year average yield of 1.9%. First Merchants Corporation's current yield is also nearly twice the average yield of 1.6% that the S&P 500 index offers.

The bank has increased its dividend for the past eight years, with a compound annual growth rate of 33% over that period of time. It should be noted that First Merchants Corporation hasn't raised its dividend since the first quarter of 2019.

Wall Street analysts surveyed by Yahoo Finance expect that First Merchants Corporation will earn $2.56 per share in 2020. Using the most recent closing price, the bank has a forward price-earnings ratio of 13.6. This is lower than the stock's five-year average price-earnings ratio of 14.5.

It appears that First Merchants Corporation is also trading below its intrinsic value, according to the GF Value line.

3 Undervalued Stocks Offering 20%+ Potential Returns
3 Undervalued Stocks Offering 20%+ Potential Returns

First Merchants Corporation's GF Value is $41.67. This gives the stock a price-to-GF Value ratio of 0.83, which earns the stock a rating of modestly undervalued from GuruFocus. Reaching its GF Value would result in a 20% gain from current levels. At this price, First Merchants Corporation's yield would be 2.5%.

First Merchants Corporation is a smaller regional bank, but offers a dividend yield that is superior to both its five-year average and that of the S&P 500. In total, investors purchasing First Merchants Corporation today could be looking at a nearly 23% total return. Those looking for exposure to the regional banking sector might want to consider First Merchants Corporation.

Old Republic International Corporation

Old Republic International Corporation (NYSE:ORI) is a multiple lines insurance company. Old Republic underwrites a variety of specialty and general insurance programs, such as property and liability, mortgage, life, title and disability. The company has a market capitalization of $5.7 billion and has produced sales of $6.4 billion over the last year.

Shareholders of record at the close of business on Dec. 4 will receive a $0.21 per share quarterly dividend on Dec. 15. The annualized dividend of $0.84 gives the stock a yield of 4.5% based off of the most recent closing price of $18.59. This tops the five-year average yield of 4% and is almost three times the yield of the S&P 500.

Old Republic has raised its dividend for 39 consecutive years. A normal raise usually falls between $0.0025 and $0.005, which explains why the stock's dividend has a CAGR of just 1.8% over the last decade.

Analysts forecast that Old Republic will earn $1.93 per share this year, which gives the stock a forward price-earnings ratio of 9.6. This is a discount to the five-year average multiple of 13 times earnings.

GuruFocus also finds that Old Republic is trading below its intrinsic value according to the GF Value line.

3 Undervalued Stocks Offering 20%+ Potential Returns
3 Undervalued Stocks Offering 20%+ Potential Returns

Presently, Old Republic has a GF Value of $22.27. Using the current share price, the stock has a price-to-GF Value ratio of 0.83. This earns Old Republic a rating of modestly undervalued from GuruFocus. If Old Republic were to trade with its intrinsic value then the stock would gain almost 20% from current levels. The yield at this price would be 3.8%, giving shareholders a possible total return of almost 24%.

Old Republic may not offer much in the way of dividend growth, but the stock is paying a higher than usual yield. Even the yield at the GF Value would be just below its five-year average. Investors looking for a high paying, undervalued insurance name could do very well buying Old Republic at the current price.

Regions Financial Corporation

Regions Financial Corporation (NYSE:RF) is a regional bank that offers banking and bank-related services to both individuals and corporate customers. The bank has nearly 1,400 locations spread out over 15 states, including Florida, Illinois, North Carolina and Texas. The bank has a market capitalization of $15 billion and has generated revenue of $6.1 billion over the last four quarters.

Regions Financial will distribute its next dividend on Jan. 4, 2021 for shareholders of record at the close of business on Dec. 4. The annualized dividend currently stands at $0.62. Shares closed Friday at $15.62, which gives Regions Financial a dividend yield of 4%. By comparison, the stock's five-year average yield is just 2.7%. This is the highest difference between the current and five-year average yield on this list. The last time Regions Financial averaged a 4%+ yield for an entire year was 2008, when the average yield was 6.4%.

The bank has raised its dividend for seven consecutive years. Regions Financial's dividend has increased with a CAGR of 31.5% over the last decade. This is slightly misleading as the dividend was cut several times during the Great Recession, so growth started from a very low base. The stock's five-year CAGR is 19%. Most recently, the bank raised its dividend 10.7% for the Oct. 1, 2019 payment, but has not raised it since.

Regions Financial is expected to earn $0.82 per share this year, which gives the stock a forward price-earnings ratio of 19. This is a substantial premium to the stock's five-year average price-earnings ratio of 12.3.

However, Regions Financial is trading below its intrinsic value as calculated by the GF Value line.

3 Undervalued Stocks Offering 20%+ Potential Returns
3 Undervalued Stocks Offering 20%+ Potential Returns

Regions Financial's GF Value is $18.64, giving the stock a price-to-GF Value ratio of 0.84 and earning it a modestly undervalued rating. Shares would need to gain 19.3% from last week's close to reach this level. Add in the 3.3% dividend yield that shareholders would be paid at the GF Value and total returns would be 22.6%.

Regions Financial is expensive compared to its recent history, but the stock still looks undervalued against its GF Value. The high yield and total return potential make Regions Financial an attractive bet in the regional banking sector.

Final thoughts

First Merchants Corporation, Old Republic and Regions Financial all offer a dividend that is more generous than their five-year average yield. Of the three, only Regions Financial is trading at a premium to the five-year average price-earnings ratio. Even then, each name on this list trades below its GF Value.

All three names have the potential to produce 20%+ total returns if they were to eventually trade at their GF Value. Thus, investors looking for returns of this nature in an otherwise expensive market could benefit from buying First Merchants Corporation, Old Republic or Regions Financial at their current prices, in my view.

Author disclosure: the author has no position in any stocks mentioned in this article.

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This article first appeared on GuruFocus.