In the last ten years, the S&P 500 index has delivered annualized price return of 10.8%. For the same period, the total returns (including dividend gains) have been at an annual rate of 12.87%. This broadly gives a sense of the type of returns blue-chip stocks can deliver.
However, within this broad time-frame, there are blue-chip stocks that have surged in quick time that’s followed by a period of price or time correction. As an example, Nvidia (NASDAQ:NVDA) stock has surged by over 200% in the last 12 months. The key to holding stocks that outperform index returns is exposure to undervalued blue-chip stocks.
If certain quality ideas have gone through price and time correction, it’s likely that returns will be robust as compared to index returns. This column focuses on three undervalued blue-chip stocks that are trading at a forward P/E of less than 10.
In my view, over an investment horizon of 36 months, these stocks are likely to outperform the S&P 500 index. Let’s discuss the business factors that supports this bull thesis.
Altria Group (MO)
In the last five years, Altria Group (NYSE:MO) stock has remained sideways. However, the stock offers a robust dividend yield of 8.53%. In my view, returns from MO stock in the next five years are likely to beat index returns. At a forward P/E of 9, MO stock looks deeply undervalued.
I must add here that for year-to-date, the consumer staples stock has trended higher by 14%. This might be an early stage of a big breakout rally. Altria has been impacted by regulatory headwinds coupled with sluggish growth as the company undertakes business transformation.
However, there are positives to talk about. First, the smokable segment continues to deliver robust cash flows. This makes dividends secure and Altria has ample flexibility to invest in the non-smokable business.
Further, the tobacco company has made inroads in the non-smokable business. Last month, NJOY received U.S. Food and Drug Administration approval for its e-vapor products. This is the only menthol e-vapor product that’s currently authorized. The company also announced a Premarket Tobacco Product Application to the U.S. FDA for its nicotine pouches. As more products are approved, growth will accelerate in the new business segment.
Vale (VALE)
I am bullish on Vale (NYSE:VALE), which is massively undervalued, on expectations of an industrial commodity bull market. VALE stock trades at a forward P/E of 5 and offers a robust dividend yield of 9.5%. I would bet on 100% total returns from the stock in the next 36 months.
The first point to note is that the world is moving towards expansionary monetary policies. Easy money implies weaker currencies and assets classes like precious metal, energy, and commodities rally. At the same time, lower interest rates are likely to support GDP growth and demand for industrial commodity will increase.
Vale is well positioned to benefit as the commodity major boosts production. For Q1 2024, iron ore sales increased by 15% on a year-on-year (YOY) basis to 8.2Mt.
Further, copper sales surged by 22%. Vale also reported free cash flow of $2 billion for the quarter. If commodity trends higher, the company is on-track to deliver FCF of more than $10 billion annually. This is likely to translate into dividend growth and value creation through share repurchase.
AT&T (T)
AT&T (NYSE:T) is another massively undervalued blue-chip stock that seems to have gained some momentum. For year-to-date, T stock has trended higher by 11%. However, at a forward P/E of 8.5, the valuation gap is significant. Additionally, the stock offers a healthy dividend yield of 5.94%.
A major concern related to AT&T was over leverage. The company has however been addressing the issue and credit metrics are improving on a sustained basis. AT&T is on track to achieve the target of net debt-to-adjusted EBITDA of 2.5x by the first half of 2025.
For the current year, the company has guided for free cash flow of $17 to $18 billion. Besides deleveraging, healthy FCF makes dividends safe.
An important point to note is that AT&T has been reporting steady growth in wireline and wireless subscribers. At the same time, the average revenue per user has been trending upwards. This makes a strong case for continued upside in free cash flows.
On the date of publication, Faisal Humayun 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.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.
