Dump XLU and Buy These Dividend Stocks

Insider Monkey’s monthly activist newsletter is approaching its third anniversary. Our stock picks generated a total return of 87% vs. 47.7% for the S&P 500 Index ETF.

Today, I am going to share a free stock pick to illustrate how we are able to beat the market by nearly 40 percentage points. I shared this stock idea in the latest issue of our monthly newsletter and I already own shares in this stock.

Aggregate earnings of the S&P 500 companies for the first 3 quarters of 2019 have been declining in comparison to the first 3 quarters of 2018. Things don’t look very pretty for the Q4 either. Overall, it looks like S&P 500 aggregate earnings for 2019 will be below its level for 2018. So how did the S&P 500 Index return more than 30% in 2019? The answer is simple: multiple expansion.

S&P 500’s forward PE expanded from 14 to 19 in 2019 mostly because Federal Reserve pushed the interest rates down, giving investors no alternatives but the stock market. Donald Trump literally bullied Fed chairman into submission and he succeeded.

This is probably the first time ever Fed had the “brilliant” idea of cutting interest rates well into an economic expansion, never minding the decades low unemployment rate and trillion-dollar fiscal stimulus.

These reckless Fed actions will undoubtedly have unintended consequences.

Today income investors are literally forced into buying utility ETFs at sky-high earnings multiples.  Utilities Select Sector SPDR Fund (NYSE:XLU) has more than $11 billion in net assets, yields 2.95% and trades for a current PE ratio of 23.6. This is madness.

XLU’s biggest holding is NextEra Energy, Inc. (NYSE:NEE) which trades for a current PE ratio of 34 and yields 1.9%.

Other dividend ETFs and stocks aren’t much different. Take Procter & Gamble (NYSE:PG). It is a boring, stable company. An income investor’s dream. We love boring, stable companies. Yet, Procter & Gamble (PG) trades at a forward PE ratio of 23.8. This isn’t normal.

At Insider Monkey we believe we can outperform major ETFs by identifying overlooked, deeply undervalued stocks. We don’t have to pay forward PEs of 24 for stable companies that are barely growing their businesses. In the last 2 months we uncovered 2 “boring” dividend stocks that pay much higher dividends than stocks like NextEra Energy or Procter & Gamble, yet trade at extremely cheap valuations.

The first stock is Adams Resources & Energy, Inc. (NYSE:AE). When we wrote about this stock its market cap was only $132 million and its annual operating cash flow was $21 million. It was extremely cheap because it had no debt and $130 million in cash.

Basically you could have bought this entire company for $2 million net of cash.

Adams Energy shares gained slightly more than 10% since our write-up, but the stock is still extremely cheap and yields 2.75%. The market is ignoring this company’s $130 million cash position. I am not. I own Adams Energy shares.

If you are in the market for a much bigger dividend yield, please continue reading.

Again, this is a free stock pick.

If you like the performance of our stock picks and would like to receive them before they are published and freely available on our website, please subscribe.

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Today, the second dividend stock I am going to talk about is a micro-cap Israeli software company that serves smaller telecom companies around the world. This is also a very “boring” company with stable earnings. Its business generated $18 million in annual revenues in each of 2016, 2017, and 2018.

Things are looking up in 2019 as its recent investments are bearing fruit. Its newly acquired German messaging group already contributed $4 million to its revenues in the last 2 quarters. So, its revenue growth in its latest quarterly report was more than 30%.

This company generated a net income of around $5 million in each of 2016, 2017, and 2018. This year the company is also on track to generate $5-6 million in net income as well.

Best of all, it has a net cash position of $14 million.

If you have $48 million, you can buy this entire company and immediately get back $14 million of your money back. Basically you are paying $34 million for a business that has been generating $5 million in earnings annually and that’s on the cusp of achieving higher earnings going forward.

Since this company has a lot of cash in the bank, it pays a once-a-year dividend which equals to the company’s EBITDA plus financial income from $14 million in cash minus taxes.

This means its dividend yield is around 11% and it is pretty safe.

The stock I am talking about is MIND C.T.I. Ltd (NASDAQ:MNDO).

Instead of investing in long-term Treasury bonds that yield 1.6% or bank deposits that yield slightly more, I bought MNDO shares for my personal account.

You can find my detailed write-up about this stock in the latest issue of our monthly activist newsletter.

The stock picks we shared in the monthly newsletter returned 87% in less 3 years and beat the S&P 500 Index funds by nearly 40 percentage points simply because we were able to identify deeply undervalued stocks that were safe to buy. There are more than 4000 stocks in the US markets. If you aren’t managing a multi-billion dollar portfolio, you don’t have to focus on the largest 500 stocks to generate returns or invest in Utilities Select Sector SPDR Fund (XLU) to get decent dividend yields. Adams Energy and MIND C.T.I are two dividend stocks that trade at very attractive valuations. An equal weighted portfolio of these two stocks is likely to generate 7% yield with plenty of potential for capital appreciation.

Disclosure: Long AE and MNDO. This article is originally published at Insider Monkey.