Desperately Seeking Dividends
A couple of weeks ago, we looked for a decent dividend stock that wasn’t trading at a ridiculous valuation. At a time when interest rates look like they’ll be lower for longer, that’s no small task.
In addition to income-hungry retirees and safe-haven seekers, dividend stocks are starting to see an influx of bond refugees, all of whom are pushing share prices higher and higher.
Even Institutional investors who normally specialize in fixed-income securities are starting to chase dividend-paying equities for yield. That’s because nearly half of global government bonds from developed-world countries—almost $10 trillion worth of debt—are trading with negative yields.
These circumstances have caused many dividend payers’ valuations to become completely disconnected from their fundamentals.
On a price-to-earnings (P/E) basis, for instance, electric utilities are currently trading neck and neck with the broad market, each at an expensive 20.2 times earnings. Similarly, dividend-paying consumer staples trade at 23.3 times earnings. And water utilities are trading at absolutely absurd levels: 30.1 times earnings.
If we were living in more normal times, these steady, but slower-growing sectors would be trading at a moderate discount to the market, not at a premium.
So if you’re a value-oriented income investor, the pickings are getting mighty slim.
Last time around, we looking for U.S.-based dividend stocks. But we also specialize in Canadian stocks, so this time around, we set our sights on the Great White North.
In our search for the best undervalued Canadian dividend payers, we actually made our criteria even more stringent than before.
Like last time, we looked for stocks that currently yield at least 3%, enjoy a consensus buy rating among Wall Street analysts, currently trade below consensus 12-month target prices, and whose price-to-earnings (P/E) ratios are below their sector’s average. That left us with 26 stocks that offer attractive yields at bargain prices.
But we still weren’t satisfied. So we further tightened our standards by looking for firms with payout ratios below 100% that generated positive free cash flows over the trailing year. After all, we want to be reasonably confident that our dividend payers can actually sustain their payouts. That more than halved our list, to 10 names.
In spot-checking a few of the companies that remained, however, we realized that we needed to add even tougher criteria. Since we like a rising paycheck, we narrowed our focus to companies that have grown their dividends over the past five years.
And while we’re income investors first and foremost, we also enjoy the prospect of price appreciation, so we screened for companies that analysts expect to grow their earnings per share over the next three to five years.
That whittled our list down to two names. But as risk-averse income investors, we had to ditch one of the stocks because it exhibits the sort of volatility that might keep us up at night.
You Snooze, You Win
That left us with Canadian life insurer Sun Life Financial Inc. (NYSE: SLF, TSX: SLF). If the mere thought of insurance is already lulling you to sleep, then good! We love dividends and hate drama, so the more boring, the better.
But here’s what’s exciting about Sun Life: Its stock has a forward yield of 3.8%, while trading at a forward valuation of just 11.4 times earnings. That means you’re getting an above-average yield at a below-average valuation.
But wait … there’s more! Management has been aggressively de-risking the business, which has translated into more reliable earnings and greater dividend growth.
To help steady its business, Sun Life has been pushing into wealth and asset management, as well as group benefits.
In addition to diversifying its business mix, the US$20 billion company has been diversifying internationally, with 44.5% of profits coming from the U.S., 36.5% from Canada, and 13.5% from Asia.
Although dividend growth flatlined after the global downturn, management started boosting the dividend again last year—and over the past five quarters the payout has grown 12.5%.
Fortunately, Sun Life’s payout ratio over the trailing year was just 42%, so its dividend definitely has more room to grow. Analysts forecast further dividend growth of 10% annually over the next two years.
But while earnings per share are expected to grow 13% next year and 7% in 2018, they’re only forecast to rise by 1% this year, to C$3.57. The main reason is that low interest rates and volatile markets can erode investment income.
Nevertheless, Sun Life enjoys largely bullish sentiment among Wall Street and Bay Street analysts alike, at 12 “buys,” five “holds,” and no “sells.” The consensus 12-month target price is US$35.73, which suggests potential appreciation of 8.3% above the current share price.