As a dividend growth investor, you could narrow the universe of stocks you willing to consider for your investment to dividend stocks that are undervalued. We will zoom-in on and discuss ten undervalued Dividend Aristocrats, their valuation, dividend yield, and performance. This undervaluation list can be a good starting point for further research, and find the right dividend stock for your portfolio.
Determining undervalued dividend stocks
For selecting the top-10, we use the theory that for stable business dividend stocks, like the dividend aristocrats, their dividend yields tend to return to the historical average over time. In this case, a dividend stock is undervalued when the current yield is higher than the 5-year dividend yield average. In general, there could be two reasons for an above-average yield: the stock price is down, and/or the dividend has increased.
We use a “Dividend Channel” as a visualization tool. The chart below shows how AT&T is how the stock is moving within a channel. As parameters, we used a dividend yield of 4% (top) and 7% (bottom) and the 5-year average yield. For example, a low share price, like in early 2019, results in a high dividend yield. Please note that the yearly dividend increases cause the channel boundaries to rise as well.
AOS as an example in more detail
A. O. Smith Corporation’s (AOS) has a current dividend yield of 2.30% which is 75% above its 5-year average of 1.32%. This indicates that this dividend stock is (current yield – average yield)/current yield = 42% undervalued. Assuming the dividend payout remains the same, the share price must increase to lower the dividend yield.
To return to the historical average dividend yield, the stock price has to increase by 75% in the next 5 years. This translates into an extra annual 11.7% increase for the stock in the next 5 years. Essential in this model is that this dividend is able to continue its streak of dividend increases.
The chart above is available on every detailed stock page for further analysis.
Top-10 most undervalued Dividend Aristocrats
So, here the list of Dividend Aristocrats as of July 30th, with the highest percentage above average five-year historical yield. The table includes the current dividend yield and also the potential annual extra return to get back to this average valuation. The corona pandemic is for many stocks one of the drivers of this undervaluation.
Although all undervalued dividend aristocrats stock prices are down in a range between ~20-50%, it is probably at least partly due to expected dividend cuts or concerns on how their business models are impacted by the corona-virus. Nevertheless, only one Dividend Aristocrat has cut its dividend yet (ROSS Stores). If you have concerns about the dividend please include some of the dividend safety metrics as well in your assessment.
By using this undervalued top-10, you may find some opportunities worthwhile considering. Please also check-out our dividend aristocrats dashboard.