Historical evidence suggests that over a long period of time, value stocks beat growth stocks, and on the whole, dividend-growth stocks beat the overall market. Thus, it may be assumed that stocks that combine the characteristics of both value and high-dividend growth stand a good chance to outperform Mr. Market in the long run. This assumption about value stocks’ outperformance versus growth and core stocks is supported by empirical research of professors Eugene Fama and Kenneth French.
In a white paper, Goldman Sachs cites work by Ned Davis Research that provides some calculations in support of the assertion that dividend growers and initiators historically beat the overall market by a respectable margin: 2.5 percentage points annually between January 1, 1972, and June 30, 2012. Now, what about specific stocks that combine low valuation and high-dividend growth?
From the universe of dividend-paying stocks with high rates of dividend growth and trailing and forward P/Es below 15x, we have selected five stocks that have good prospects for strong total returns in the future. The list is diversified across industries and consists of stocks that have yields of at least 2%. Below is a quick glance at the five stocks’ strong attributes. Most of these stocks are priced at levels that can be considered good entry points for the long run.
CA, Inc. (NASDAQ:CA) is an enterprise IT management software firm that is currently trading at trailing and forward P/Es of 10.4x and 10.2x, respectively. The stock is down about 8% over the past year and up only 11.8% over the past five years. Its dividend has risen at a spectacular rate over the past half-decade, with annualized increases averaging 33.5%. Currently, CA, Inc. (NASDAQ:CA) is yielding 3.9% on a payout ratio of 41% of its current-year EPS estimate, at 39% of trailing free cash flow.
The company holds more than 20% of its total assets in cash and short-term investments, and trades at a high free cash flow yield of about 8%. CA, Inc. (NASDAQ:CA) is very shareholder friendly, committed to paying 80% of its expected cumulative free cash flow in dividends and share buybacks through 2014.
CA, Inc. (NASDAQ:CA)’s weak performance over the past few years reflects analysts’ concerns about the future prospects of the company’s low-growth mainframe business, and the fierce competition that has squeezed margins in the growing enterprise segment. The company was recently identified as a leveraged buyout candidate by Bank of America-Merrill Lynch analysts, given that it fits the preferred profile, i.e. boasting a stable cash flow, an enterprise value below $20 billion, low corporate debt, and an attractive valuation. Last quarter, billionaire Cliff Asness was a big fan of the stock.
Ensco PLC (NYSE:ESV) is a leading supplier of offshore contract drilling services to the oil and gas industry. It is currently trading at trailing and forward earnings multiples of 11.0x and 9.0x, respectively—well below industry norms. The stock is up 10.2% over the past 12 months, and about flat over the past five years. With a growing cash flow, the company has boosted its dividend at a five-year CAGR of 74.7%. It recently hiked its dividend by 33%, citing strong visibility of future cash flows amid an $11-billion revenue backlog and growth driven by six additional rigs to be in operation by the end of 2014.
Currently, Ensco PLC (NYSE:ESV) is yielding 3.3% on a payout ratio of 30%, based on its current-year EPS estimate. Analysts give the stock a very bullish outlook, forecasting its long-term EPS CAGR to settle in at nearly 30%. This sanguine EPS outlook is based on a robust demand for both deep- and shallow-water offshore drilling, driven by record-high capital spending on oil and natural gas E&P. The company is expected to see strong day-rate improvements in the upcoming period. Last quarter, Ensco PLC (NYSE:ESV) was popular with Arrowstreet Capital and David Einhorn’s Greenlight Capital.
IAMGOLD Corporation (USA) (NYSE:IAG), a Canadian small-cap gold miner, is a good value stock, trading at trailing and forward multiples of 8.5x and 10.0x, respectively. IAMGOLD Corporation (USA) (NYSE:IAG) is also trading at a 30% discount to its book value, with a price-to-book ratio that is 60% below the stock’s average ratio over the past five years. Shares have lost 45% of their value over the past 12 months, and are down 7% over the past five years.
IAMGOLD Corporation (USA) (NYSE:IAG) has been a major dividend-grower, so to speak, increasing dividends at an average CAGR of 33% over the past five years. Currently, the gold miner is yielding 3.4% on a payout ratio of 30% of its current-year EPS estimate. The company reported a drop in its 2012 EPS, based on flat revenues, as gold output declined and operating costs and exploration expenses increased. The company’s 2013 outlook calls for an increase in gold production of between 5.4% and 14.4% from 2012.
However, total cash costs are also expected to surge, by 30%, based on the guidance midpoint values. Still, analysts forecast the company’s EPS to rise by 20.5% next year, though their consensus forecast of long-term EPS CAGR (about 3%) is modest.
Microsoft Corporation (NASDAQ:MSFT), the world’s third-largest tech firm by market capitalization, is also a good value play, with trailing and forward P/Es of 11.1x and 9.1x, respectively. The stock is down 10.6% over the past 12 months but is up 2.5% over the past five years. Like the aforementioned stocks, Microsoft Corporation (NASDAQ:MSFT) has also been a devoted dividend-grower. Its dividend has been growing at an average CAGR of 15.4% over the past half-decade. Currently, the stock pays a dividend yield of 3.3% on a payout ratio of 32%, based on current-year EPS estimates.
If you’re reading this, then you do likely know that Microsoft Corporation (NASDAQ:MSFT) is a leader in its industry with globally recognized products, but it’s important to point out that it also boasts strong balance sheet, with 53% of its total assets in cash and short-term investments, and a long-term debt-to-equity ratio of only 16%.
Now, you’re probably also aware that Microsoft Corporation (NASDAQ:MSFT) has seen relatively weak demand for its new products, Windows 8 operating system, and Surface tablet. Windows 8 was heralded as a solution to the so-called ‘PC slump,’ but so far, it has failed to deliver on that objective. Hopes are now pinned on the upcoming release of a Windows 8 update, codenamed “Windows Blue,” which will provide incremental system updates at a lower cost. Despite the challenges, analysts forecast the company’s long-term EPS CAGR at 9.1%. Microsoft Corporation (NASDAQ:MSFT) is popular with value investors, including Donald Yacktman and Boykin Curry.
Harris Corporation (NYSE:HRS), a communications and IT firm heavily dependent on government revenues, is another stock that boasts both value and dividend growth characteristics. The company’s shares are trading at trailing and forward earnings multiples of 8.9x and 9.1x, respectively. They also appear to be undervalued based on a free cash flow yield of nearly 10%. The stock is up 5.2% over the past 12 months, but is still down 4% over the past five years.
Harris Corporation (NYSE:HRS) has produced robust dividend growth over the past five years, increasing dividends at an average CAGR of 20.8%. At present, Harris Corporation (NYSE:HRS) is yielding 3.2% on a payout ratio of 29%, of its current-year EPS estimate.
Planned defense budget cuts—and those resulting from the sequestration process—are likely to have an adverse effect on the company’s performance. Still, despite the threats, the company sees opportunities in both the U.S. and in international markets, especially with regard to RF Communication products. Based on stronger-than-expected RC Communications growth, the company recently revised upward its fiscal year 2013 revenue guidance, but it also lower EPS guidance for the same period. In terms of hedge fund ownership, billionaire Michael Price holds a $16 million stake in this stock.
So, there you have it. Five stocks that have strong growth and dividend potential, that are also very, very attractively priced. The key, in our mind, then, is to determine if any of these companies are trading at low multiples because they deserve to, hence the phrase “value-trap.” Of this group, it appears that Microsoft Corporation (NASDAQ:MSFT)may offer the most downside, as it’s easy to make the case that its products just aren’t up to snuff. On the other hand, the Surface is still early in its lifecycle compared to Apple Inc. (NASDAQ:AAPL)’s iPad, so it’s hard to judge just yet.
Regardless, we’d pay the closest attention to each of these stocks moving deeper into 2013, and Harris Corporation (NYSE:HRS), IAMGOLD, Ensco, CA, and possibly Microsoft—if you’re up to it—each give investors a unique way to play the “Golden Trifecta” of growth, income and value. Check out how hedge funds are trading these stocks on Insider Monkey.