Dividend Aristocrats are those unique kinds of stocks that rarely go on sale. For more than 25 years, these companies have been churning out ever-increasing dividend payments that show they are more than capable of handling the ups and downs of the economy -- or their respective industry cycles. Every once in a while, though, the market forgets the long-term earnings power of these companies, and their stocks become good bargains.
Today, three dividend stocks -- propane distributor and utility UGI Corporation (UGI 1.00%), investment management company T. Rowe Price (TROW +1.32%), and oil and gas giant Chevron Corporation (CVX 2.21%) -- look underestimated by the market. Let's take a look at these three Dividend Aristocrats and see why the combination of their businesses and valuations makes them cheap stocks worth considering for your portfolio.
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Blame it on the rain
As a propane distributor, UGI's business is highly dependent on the weather. Propane is primarily used as a heating fuel, and if you can remember from last winter, it was an unusually warm one. The company was able to offset some of the weakness in propane demand with strong results from its utility segment and some acquisitions. As a result, it was able to generate record earnings for the fiscal year. Despite producing strong results in what would typically be considered a down year, Wall Street is still treating this stock with kid gloves as it carries a total enterprise value to EBITDA of 8.5 times.
I'll admit that valuation doesn't scream cheap stock, but you need to consider the most recent annual results as well. These record results were produced even when the company fully admitted that propane volumes were down across the board. If we were to see a return to more normal weather conditions this coming winter, then UGI's earnings will likely be much, much stronger. If that is the case, then today's rather modest stock price will look demonstrably cheap.
High return + modest valuation = cheap stock
A cheap stock is a relative term. A company that generates higher rates of returns will almost always command a higher valuation. One great example is T. Rowe Price Group. While the stock isn't the cheapest one out there -- it trades at a very middle-of-the-road price-to-earnings ratio of 16.5 times and a total enterprise value-to-EBITDA ratio of 9.1 times -- it's the combination of its high rates of returns and its relatively modest valuation that makes it a cheap stock.
What makes T.Rowe Price unique versus other investment management companies is that company doesn't use debt to juice returns. Since the company is debt-free, it tends to stand the ups and downs of the market cycles better than others. Yet at the same time, the investment manager continues to generate strong returns on equity without even needing to rely on debt. This high-return business generates lots of free cash flow that management has used to reward shareholders with a strong dividend that yields 3.1% and a robust share repurchase program.
TROW dividend. Data by YCharts.
For those kinds of high-quality returns over the long run, investors should expect to pay some sort of premium to the market. Yet today, shares of T. Rowe Price are valued rather modestly. The combination of high returns plus modest valuation adds up to a cheap stock.
Not cheap by traditional standards, but dig deeper
If you look at Chevron simply from any earnings- or sales-based ratio, then in no way does it look like a cheap stock. Since it has taken losses over the past 12 months, it doesn't even have a P/E ratio, and its total enterprise value-to-EBITDA ratio is 14.7 times. Even for a high-growth company, paying close to 15 times EBITDA is a hefty price tag, let alone a slower-growth business like integrated oil and gas.
Here's the thing that investors need to consider, though. When it comes to cyclical industries like oil, you can't simply look at earnings-based ratios and call it a day. You also have to look at where it is in the cycle. In this case, we are in one of the cycle lows of the industry as oil prices are low. So it's much more common to see a higher valuation multiple given to the company. As oil prices rise and earnings improve, that valuation multiple will rapidly shrink.
Another way to look at Chevron from a valuation standpoint is price to tangible book value. This way, we are valuing the underlying assets that generate future earnings rather than the earnings themselves. Today, shares of Chevron carry with them a price to tangible book value of 1.41 times, which is well below the company's 20-year historical valuation of 2.27 times. Perhaps the company's investments in higher-cost projects like its Australian LNG facilities mean that it won't generate returns as high as it has in the past and the earnings power of its underlying assets isn't as strong as it once was, but today's stock price seems to suggest that shares are very cheap for a stable Dividend Aristocrat.
