Dividend investors have no fewer than 41 high-quality undervalued blue-chip stocks to choose from.
That’s according to Investment Quality Trends, a dividend stock advisory service edited by Kelley Wright. According to my firm’s performance tracking, it is one of the best-performing investment newsletters over the long term, beating the broad U.S. stock market by a large margin. In addition, it is in first place for risk-adjusted performance over both the trailing 20- and 30-year periods among services I monitor.
To be sure, this group of 41 stocks constitutes just 16.8% of the 244 blue-chip dividend-paying stocks on Wright’s watch list. But the current size of Wright’s undervalued category is nearly double what it was at the beginning of the year.
That’s a big improvement. Indeed, at the beginning of January, Wright’s valuation model found that, among the 244 stocks he monitored, there were twice as many overvalued as undervalued stocks. Today, in contrast, the two groups are roughly the same. Credit for this improvement goes both to the market’s turmoil over the last several months, as well as continued improvement in blue chips’ fundamentals.
Below are five stocks on Wright’s list of top-10 undervalued stocks that are also recommended for purchase by at least one other of the top-performing investment newsletters I monitor:
• CVS Health CVS, -1.53%
• IBM IBM, -1.96%
• PepsiCo PEP, +0.59%
• Procter & Gamble PG, -0.06%
• Walmart WMT, -0.59%
Does this mean that the market as a whole is undervalued? Unfortunately not.
Consider first what I found upon putting the output of Wright’s model in the context of the 50+ years that Investment Quality Trends has been analyzing dividend-paying stocks. Twice each month since the 1960s, that model has put into four categories several hundred dividend payers with sound balance sheets and a long history of paying dividends:
• The “Undervalued” category contains stocks whose dividend yields are close to the high ends of their historical ranges;
• The “Overvalued” category contains those with yields close to the low ends of their ranges
• The “Rising Trend” category includes those stocks whose prices have risen enough to move them out of the “Undervalued” category, but not far enough to make it to “Overvalued” status;
• The “Declining Trend” category is the opposite of the “Rising Trend” category.
When I fed the historical data into my PC’s statistical package, I found that the stock market’s subsequent return has tended to be higher when the proportion of stocks in either the Undervalued and Rising Trend categories has been larger — and lower when most of the stocks are in the Overvalued and Declining Trend categories.
Currently, a total of 53.7% of Wright’s universe is in these two categories. While that’s below the five-decade average of 59.3%, the current percentage is still significantly higher than the below-30% readings that were registered in the weeks leading up to the top of the Internet bubble in early 2000 and the top of the bull market in October 2007. (The all-time low for the percentage in these two categories came in mid-1999, when it stood at 26%, less than half where it stands now.)
So there’s a “glass half-full or half-empty” story to be told from Wright’s data.
A similar story emerges when we focus on the stock market’s shareholder yield (or payout yield), which represents the combination of both dividends and net share repurchases. The chart below shows that, as of the end of last year, the S&P 500’s SPX, -1.19% shareholder yield stood at 4.12%. In contrast, the dividend yield averaged 4.73% during the prior decades in which dividends were the primary way in which companies returned cash to shareholders. (This average is based on data back to 1871 compiled by Yale University’s Robert Shiller, and extends up to 1998, which is when the accompanying chart begins.)
The current reading is not so far below the historical average as to constitute an all-or-nothing sell signal. Indeed, given the variability in the data, a statistician would be hard pressed to show that the current reading is significantly different than the historical average — especially given the surge in companies’ buyback activity so far this year.
Many dividend investors, including Wright, focus less on timing the market and more on exploiting the market cycles to pick up quality stocks that are out of favor. Over most three- to five-year time frames, he has found, such a stock-picking approach has produced handsome returns.
I know this conclusion is frustrating to both the bulls and the bears, who prefer unhedged, all-or-nothing forecasts. But most of the time even the best of indicators are not at one or the other extreme which provides that kind of a forecast. Now appears to be just such a time.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com .