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With an equal focus on robust returns and capital protection, it’s essential to create a balanced portfolio. This would be a combination of growth stocks and dividend stocks.
Growth stocks are high-beta stocks and deliver robust capital gains under favorable market conditions. On the other hand, undervalued dividend stocks are low-beta stocks and provide regular cash flows through dividends.
However, it does not imply that dividend stocks provide no capital gains. With some market correction and uncertainty in the recent past, it’s an excellent time to buy high-quality, undervalued dividend stocks. Finding such dividend stocks and investing in them can give investors the advantage of dividend gains and healthy capital gains.
Top 4 Undervalued Dividend Stocks To Buy Now For Robust Total Returns
Undervalued Dividend Stocks To Buy Now
Here are four undervalued dividend stocks that are worth holding for the next few years.
Pfizer (NYSE: PFE) is the top name to consider among undervalued dividend stocks. The stock trades at a forward price-to-earnings ratio of 7.6 and offers investors a dividend yield of 3.2%. Considering the valuation, a break-out on the upside seems impending.
It’s also worth noting that Pfizer is in the pharma business and is immune to economic shocks. The company has a deep pipeline of drugs in various phases of clinical trials. As these drugs enter the market, there will be visibility for sustained top-line growth.
Pfizer has also benefited in terms of robust free cash flows from the covid-19 vaccine. Just for 2021, the company delivered a free cash flow of $29 billion.
This allows the company scope for significant investments in research and development. At the same time, Pfizer has been aggressive on the acquisition front in the last few quarters. This will further boost the company’s development pipeline.
Overall, Pfizer stock has a low beta and the company has a clear growth visibility. Current valuations seem attractive for a stock that can potentially offer dividend growth on a sustained basis.
British American Tobacco (NYSE: BTI) is another quality dividend stock that trades at an attractive valuation. Currently, BTI stock offers a dividend yield of 6.95%, and dividends seem sustainable. Furthermore, the stock trades at a forward P/E of 9.2.
Regarding business development, British Tobacco is in a phase of transformation. The company focuses on increasing growth and market share in the non-combustible segment. The company already has 20.4 million users of non-combustible products. This new segment has also delivered revenue growth at a CAGR of 31% between 2018 and 2022.
Having said that, the company’s combustible segment remains the cash cow. I also believe that the core combustible segment will continue to deliver positive free cash flow in the coming years. This cash will be deployed towards investment in non-combustible business growth.
To put things into perspective, British American has guided for 40 billion pounds in free cash flow (before dividends) over the next five years. This will ensure value creation through dividends and share repurchase.
Overall, British American seems to be moving in the right direction regarding portfolio transformation. The stock is a buy at current levels with strong free cash flow visibility.
In general, industrial commodity stocks have a lower price-to-earnings ratio due to the industry’s cyclical nature. However, even after considering this factor, Vale (NYSE: VALE) stock looks undervalued at a forward P/E of 3.8.
Further, VALE stock offers investors a dividend yield of 22%, and I believe that dividends are sustainable considering the cash flows. It’s worth noting that the stock has declined from recent highs of $21.9 to current levels of $13.1. This correction seems like a good accumulation opportunity.
Iron ore prices have recently declined, which is a key reason for Vale’s stock correcting. However, it seems that the worst is discounted in the stock. With the possibility of a stimulus in China, the reversal rally can be substantial.
For Q2 2022, Vale reported an EBITDA of $5.5 billion. This would imply an annualized EBITDA potential of $22 billion. It’s not surprising that Vale returned $11.5 billion to shareholders in 2022 in the form of dividends and share repurchase.
Even with some decline in EBITDA due to a weak macro environment, free cash flows are likely to remain strong. Vale also has a decent balance sheet with no significant debt refinancing commitment. Once temporary growth headwinds are overcome, the stock is positioned for a sharp reversal rally.
Considering the geo-political frictions globally, it’s essential to hold defense stocks in the portfolio. Lockheed Martin (NYSE: LMT) is an attractive stock that looks undervalued at a forward P/E of 16.4. LMT stock also offers a robust dividend yield of 2.5%.
Among the reasons to be bullish, Lockheed Martin has an order backlog of $135 billion. This backlog provides revenue visibility for the next 12-24 months. The company has already guided a free cash flow of $6 billion for 2022. For the next year, a similar FCF is expected.
An important point to note is that most European countries have fallen short of the NATO defense spending target. With the recent escalation in tensions in the region, Lockheed stands to benefit as Europe ramps-up defense spending.
Therefore, the company’s order backlog will likely swell in the coming years. This is likely to translate into higher cash flows and a potential increase in dividends.
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