Benjamin Graham, the father of value investing and mentor to Warren Buffett, explained that in the short term, the market is a "voting machine" and stocks are judged by their popularity with investors. But in the long term, he continued, the market is a "weighing machine" -- meaning a stock's fundamentals are what matter most.
Undervalued dividend stocks are especially attractive in today's market, which appears to be fully valued at best and meaningfully overvalued at worst. That's because when a dividend stock is trading below its fair value, the starting dividend yield is higher -- mitigating the risk of excessive downside in a market correction.
Astute investors can take advantage of the occasional disconnect between a dividend stock's popularity with investors and its true fundamentals. Here are two dividend stocks offering yields above 4% that are solid value picks for patient investors.
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A battle-tested REIT
The first value stock that presents an under-the-radar opportunity compared to the broader market is the real estate investment trust (REIT) STORE Capital (STOR).
STORE Capital held up well last year considering that health club tenants (5.3% of Q2 2020 annualized base rent or ABR) and movie theater tenants (4% of Q2 2020 ABR) were adversely impacted at the height of the COVID-19 pandemic. This resulted in its cash collection rate hitting its low point of 73% in Q2 2020. The first reason STORE Capital kept up is that the bulk of the company's Q2 2020 ABR was derived from tenants that offer a variety of everyday services including full-service restaurants (8.5% of Q2 2020 ABR), limited-service restaurants (5.1% of Q2 2020 ABR), and early childhood education (6.1% of Q2 2020 ABR).
Secondly, STORE Capital's cash collection rate in Q2 2020 lined up with 74% of its ABR being derived from tenants with investment-grade balance sheets. Because tenants with this rating tend to have access to more liquidity and generate more cash flow than non-investment-grade tenants, STORE Capital had fewer issues in collecting rent from most of its tenants.
Despite the impact of COVID-19 on cash collections last year, STORE Capital's adjusted funds from operations (AFFO) per share dipped only 8% from $1.99 in 2019 to $1.83 in 2020. After withstanding arguably the most formidable year in its seven years trading publicly, STORE Capital is poised to nearly recover to pre-pandemic levels this year and return to growth next year.
STORE Capital forecasts that its AFFO per share will be $1.94 to $1.97 for this year, which would represent 6% to 7.6% growth over last year. Its guidance is primarily due to two factors.
The first factor is the economic reopening stemming from rising vaccination rates in the U.S., which will help stabilize STORE Capital's revenue in its existing portfolio. Secondly, STORE Capital has executed more than $600 million in acquisitions through the first half of this year versus only about $400 million in the year-ago period. These acquisitions will drive revenue higher, which will flow down to its AFFO. The most obvious display of management's confidence in the future was the company's 6.9% increase in its quarterly dividend from $0.36 per share to $0.385 per share announced earlier this week.
Based on its most recent AFFO guidance for this year, the stock trades at less than 18 times this year's AFFO. This is well below the S&P 500's estimated price-to-earnings ratio of 22 for this year. AFFO is the closest measure of profitability to the S&P 500's earnings per share estimate. That's because REITs like STORE Capital have significant amounts of non-cash expenses like depreciation and amortization that lower their net income (from which EPS is calculated), which is factored into AFFO per share. This metric suggests that STORE Capital is a solid buy given its fundamentals. Its 4.4% yield offers investors plenty of reason to hold their position while they wait for the market to reward the stock with a higher valuation multiple.
Image source: Getty Images.
A well-prepared pharma stock
The next value stock on our list is the pharma stock AbbVie (ABBV 1.06%).
At this point, it's well known to the investing community that the patent for AbbVie's immunology drug Humira used to treat various forms of arthritis and inflammatory bowel disease will be expiring in the U.S. in 2023.
AbbVie bears argue that the looming decline in Humira's U.S. revenue (where approximately 82% of Humira's $9.94 billion in first-half revenue was derived) will be too much for the company to make up. This concern certainly has some merit, but I believe it has been somewhat exaggerated by AbbVie's bears.
That's because AbbVie's U.S. sales for this year will be around $16 billion to $17 billion based on the first half of revenue. Analyst Geoffrey Porges from SVB Leerink, an investment bank specializing in healthcare, estimates that in 2023, AbbVie could still generate $14.5 billion in U.S. revenue from Humira. This is despite competition from several biosimilars that will enter the U.S. market in 2023.
This estimate is well above Wall Street's doom and gloom consensus estimate of $10.5 billion in U.S. revenue during 2023. Fortunately, AbbVie has drugs to offset Humira's upcoming revenue declines.
AbbVie expects additional indications from its other two immunology drugs on the market -- Rinvoq (approved for rheumatoid arthritis) and Skyrizi (approved for plaque psoriasis) -- will allow combined sales from the two drugs to reach $15 billion by 2025.
With just the current indications alone, AbbVie raked in $1.93 billion in combined first-half sales from the two drugs -- a doubling from the $865 million in revenue produced in the year-ago period.
Since AbbVie expects that next year Skyrizi will be approved for Crohn's disease and psoriatic arthritis and Rinvoq will be approved for ulcerative colitis, I believe its combined revenue forecast is reasonable.
In addition to AbbVie's intact operating fundamentals ahead of Humira's U.S. patent expiration, the current 4.8% dividend yield appears to have a big buffer built into it.
Based on AbbVie's forecasted adjusted earnings per share (EPS) of $12.52 to $12.62 and dividends per share of $5.20 for this year, its payout ratio will be around 41% for the year.
AbbVie is trading at less than nine times this year's anticipated adjusted EPS, which leaves value investors with an ample margin of safety while collecting a whopper of a yield.
