Stocks with attractive, sustainable dividend yields are highly desirable to income investors. Moreover, if their stock prices are significantly undervalued, they become even more compelling investments. The combination of reliable, lucrative current income with long-term wealth compounding is a passive income investor’s dream.
High-yield and attractive long-term total returns are definitely not mutually exclusive. Thanks in part to rising interest rates, we are at a rare moment in modern market history where income investors can buy high-yielding stocks that also have very defensive business models and reliable dividend growth potential. When you combine the high yields with dividend growth and the potential for valuation multiples to increase over time back toward more historical norms, these stocks could deliver outstanding risk-adjusted total returns for shareholders.
This article discusses three undervalued dividend stocks that offer strong yields and are undervalued. Therefore, they present opportunities for high total returns over time.
Walgreens Boots Alliance (WBA)
Walgreens Boots Alliance (NASDAQ:WBA) is the largest retail pharmacy in the US and Europe. It operates in over nine countries with 13,000+ stores. It also employs over 315,000 people across the U.S., Europe and Latin America.
Walgreens’ competitive advantage stems from its large-scale and extensive network in a significant, growing industry. The company maintains a reasonable payout ratio, providing income stability for investors. Despite a decline in earnings in 2020, Walgreens has historically demonstrated resilience. For example, it suffered only a 6.9% drop in earnings in 2009 .
Walgreens has experienced an average annual earnings per share (EPS) growth rate of 7.6% over the past decade, driven by top-line growth, steady net profit margins, and a reduced number of outstanding shares. However, in 2020, EPS declined by 21% due to the Covid-19 pandemic.
Despite short-term challenges, long-term growth prospects are promising. This is due to factors like an aging population, focus on becoming a health destination, and the company’s role in Covid-19 vaccinations and testing. While the tailwind from Covid-19 vaccinations is subsiding, Walgreens will likely continue to grow in the future.
Between its 4% anticipated EPS compound annual growth rate (CAGR), 5.4% expected annualized tailwind from multiple expansion over the next half decade, and 5.5% current dividend yield, WBA is positioned to deliver double-digit annualized total returns over the next half decade. As a result, it appears to be a compelling buy while also offering investors attractive, sustainable and growing current income.
Kinder Morgan (KMI)
Kinder Morgan (NYSE:KMI) is one of the largest energy companies in the U.S. It focuses on midstream storage and transportation of oil, gas and other energy commodities. The company operates around 83,000 miles of pipelines and 144 terminals. These pipelines transport natural gas, refined petroleum products, crude oil and carbon dioxide. Kinder Morgan generates about 90% of its cash flow from fee-based services, and the vast majority of its counterparties are investment grade. As a result, it operates in many ways like a toll road and generally avoids commodity price risk.
Kinder Morgan operates in the cyclical energy sector but maintains fairly stable cash flows due to its business model. Although the company previously had a low interest coverage ratio and high debt, leading to a dividend cut in 2016, the new dividend payout level is secure. The company used avings from the dividend reduction to pay down debt and improve the balance sheet, resulting in credit rating upgrades from Standard & Poor’s and Moody’s. As one of the largest energy companies in the U.S., Kinder Morgan benefits from significant network and economies of scale advantages. It is the largest natural gas transporter, moving about 40% of the gas used in the U.S., as well as the largest independent transporter of petroleum products, carbon dioxide and terminals operator.
Kinder Morgan’s future growth catalysts include new pipeline and terminal projects, driven by the increasing demand for natural gas as it replaces coal. However, political headwinds may slow down growth for the company. In 2023, Kinder Morgan plans to invest in growth projects and joint ventures, funding them through internally generated cash flow without accessing capital markets. The company’s distributable cash flow per share is expected to be around $2.13 in 2023. It will likely increase steadily over the next half decade due to growth projects and share repurchases.
While KMI’s anticipated 2.6% distributable cash flow per share CAGR over the next half decade is relatively unimpressive, the 6.2% dividend yield and expectations of a flat valuation multiple push the total return profile to the high-single-digits. As a result, KMI looks like a worthwhile investment for dependable and lucrative income and solid total returns.
Verizon (VZ)
Verizon (NYSE:VZ) is a leading wireless carrier in the U.S. It generates 75% of its revenue from wireless services and 25% from broadband and cable services. Verizon’s network reaches approximately 300 million people, covering 98% of the U.S. population.
Verizon offers a high and stable dividend yield, benefiting from increased cash flow due to a lower tax rate and reduced net debt levels. The company is known as the best wireless carrier in the U.S. It boasts strong customer retention and potential for upselling higher-priced plans. Additionally, Verizon is rolling out 5G service, giving it a competitive edge and making its stock resilient during market downturns.
Verizon’s EPS has grown at 2.6% annually over the past decade. With a slightly reduced forward expected growth rate of 2.5%, the company’s 2023 guidance suggests a potential EPS of $5.32 per share by 2028.
Like Kinder Morgan, Verizon likely won’t be a big growth stock in the coming years. It has an estimated CAGR of just 2.5% over the next half decade. That said, its 6.7% current dividend yield — which appears to be quite safe and very sustainable for the foreseeable future — along with the 5.7% expected annualized tailwind from valuation multiple expansion mean that the company is well-positioned to deliver double-digit annualized total returns over the next five years. As a result, it looks like it could be a great investment for generating substantial returns alongside a lucrative income stream.
On the date of publication, Bob Ciura did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
