There are several strategies that investors can choose from, such as growth investing, value investing, and dividend investing. But investors can also combine multiple strategies to achieve the desired results. For example, value investors that look for stocks trading below their intrinsic values may also want to consider buying dividend stocks. Many of the market’s undervalued stocks pay dividends, which help an investor collect income while waiting for the stock valuation to rise.
At Sure Dividend, we are firm believers that investors can generate superior long-term returns by combining value and income investing strategies. In our view, buying undervalued stocks is good, but buying undervalued dividend growth stocks is even better. Specifically, we favor the Dividend Aristocrats, a group of 65 stocks in the S&P 500 Index that have raised their dividends for at least 25 consecutive years.
Dividend Aristocrats Overview
There are currently 65 Dividend Aristocrats, in multiple industries such as industrials, consumer staples, health care, and more. The Dividend Aristocrats have proven themselves to be recession-resistant businesses, with the ability to quickly return to growth after economic downturns while maintaining constant dividend growth. These qualities have served investors well. In the past decade, the Dividend Aristocrats generated total returns of more than 13% annually, including dividends.
To raise its dividend for over 25 years in a row, a company must possess durable competitive advantages that enables it to survive threats from new competitors. It also operates in an industry that is not overly cyclical, which is why many economically-sensitive industries such as technology and automakers are under-represented on the Dividend Aristocrats list. Instead, the list is tilted toward companies operating in steady industries, that can continue to sell their products every year regardless of the economic environment.
The past 25+ years has included multiple recessions, wars and other global conflicts. And yet, the Dividend Aristocrats have continued to increase their dividends year after year. For income investors looking for a mix of growth and safety, the Dividend Aristocrats are a source of potential investment opportunities. We believe it is even better to buy the Dividend Aristocrats when they are undervalued.
Valuation is an important characteristic that too often gets ignored. But even high-quality companies such as the Dividend Aristocrats can be poor investments, if too high a price is paid for the shares. Therefore, we believe investors who combine income and value investing strategies can generate superior long-term results. The following section will discuss a stock that we feel is an attractive investment for value and income investors.
AT&T (T): Dividend Aristocrat For Value And Income
AT&T is an example of a Dividend Aristocrat we view favorably not just because of its long history of dividend increases and high dividend yield, but also because the stock is undervalued. AT&T is a giant telecommunications company with a diversified list of services including wireless, broadband, cable television and satellite TV under the DirecTV brand. AT&T has a market capitalization of $212 billion.
AT&T, like many other companies, has taken a hit from the coronavirus pandemic which caused the U.S. economy to slip into a recession in February 2020. In the second quarter, AT&T reported revenue of nearly $41 billion, a decline of 9% from the same quarter last year. Adjusted earnings-per-share declined 6.7% as the company managed to cut costs somewhat to boost the bottom line.
Despite the declines in revenue and earnings-per-share to begin 2020, AT&T has durable competitive advantages. Specifically, it dominates the telecommunications industry alongside Verizon Communications (VZ). AT&T sits near the top of an industry which sees steady demand, even during recessions. After all, consumers are extremely reluctant to go without their cell phones and Internet service, even in a severe economic downturn. This provides AT&T with steady cash flow, which fuels its hefty dividend.
AT&T generates a great deal of cash flow. In the most recent quarter, the company produced $7.6 billion of free cash flow. Such a high level of free cash flow means the company can invest in future growth initiatives, pay dividends to shareholders and also pay down debt. AT&T’s net debt-to-EBITDA ratio was ~2.6x at the end of the quarter.
While the short-term view is uncertain due to the coronavirus pandemic, the long-term future remains bright for AT&T. Television, wireless and broadband service will continue to see strong usage, particularly as 5G rollout looms. In June, AT&T announced it had turned on 5G service to 28 additional markets, bringing the total to over 350 markets in the United States. Furthermore, in the most recent quarter AT&T invested $1 billion to acquire 5G spectrum as the company further builds toward this growth catalyst.
In addition, content is a major growth catalyst for AT&T in the years ahead. The company’s huge acquisition of Time Warner in 2018 gave it ownership of a multitude of popular media brands including CNN, HBO and the Turner networks. It also gave AT&T a production studio and broadcast rights to multiple major sports leagues. This is a very beneficial acquisition for AT&T as it provides much-needed access to content creation, which is increasingly important in the age of cord-cutting and the rise of streaming.
Expected Returns For AT&T
Expected returns are a combination of a company’s earnings-per-share growth and dividends, plus any changes in the valuation multiple of the stock. The best investment opportunities are often those stocks with positive EPS growth potential, a high dividend yield, and a low valuation. This is why we view AT&T favorably right now—not only does it offer a high dividend yield of 7% and promising future growth catalysts, but it is also undervalued.
Earnings and Valuation
Analysts currently expect AT&T to generate earnings-per-share of $3.20 for 2020. With a share price of $29.72 as of this writing, AT&T currently trades for a P/E ratio of 9.3x. We feel this is too low for a high-quality company with strong cash flow and future growth potential. Our fair value estimate is a P/E of 12 which is more representative of a company of AT&T’s caliber. If the valuation multiple expands to 12 by 2025, the multiple expansion would generate positive returns of 5.2% per year over the next five years.
In addition, the stock has a high yield of 7%, meaning investors could earn 12%+ annual returns just from dividends and multiple expansion. If AT&T can also generate positive earnings-per-share growth, total returns would be even higher. With over 30 years of annual dividend increases, a high starting yield and a low valuation, we view AT&T as one of our top Dividend Aristocrats today.