During a stock market sell-off, strong fundamentals and a reasonable valuation matter more than ever. No one knows what will happen in the short term. But profitable businesses that can support stable and growing dividends give investors a passive income stream that compensates them for their patience.
3M (MMM -1.05%), Caterpillar (CAT 0.07%), and Starbucks (SBUX 1.00%) are three excellent dividend stocks that also happen to have inexpensive valuations. Here's what makes each a great buy now.
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3M is too cheap to ignore
3M has many of the same problems as other industrial conglomerates right now. It's struggling to offset higher costs caused by inflation, plus it's dealing with the lingering supply chain bottlenecks and pandemic-induced challenges. 3M is also still in the process of a restructuring that is meant to streamline its operations and boost growth. But at least in the short term, 3M's growth prospects are paltry.
In its strategic update and 2022 outlook from Feb. 14, 3M said it expects 1% to 4% year-over-year sales growth, 2% to 5% organic sales growth, earnings per share between $10.15 and $10.65 compared to $10.12 in 2021, and operating cash flow of $7.3 billion to $7.9 billion compared to $7.5 billion in 2021. However, the inflation situation has escalated since 3M reported its forecast, which could mean the company will lower its full-year guidance when it reports its first-quarter 2022 results on April 26.
What 3M has going for it is a dirt cheap valuation, a strong balance sheet, and a high dividend yield. 3M has a price-to-earnings (P/E) ratio of 14.6 and a forward P/E ratio of 14.2. 3M also has net total long-term debt of just $12.6 billion, a debt-to-capital ratio of 53.6%, and a financial-debt-to-equity ratio of 0.17 -- all of which indicate the company's balance sheet remains healthy despite 3M's lackluster performance in recent years. 3M is also a Dividend King, which is an S&P 500 component that has paid and raised its dividend for at least 50 years. 3M has a dividend yield of 4%.
Caterpillar stock isn't expensive despite being near an all-time high
Unlike 3M, which is more of an income stock/value stock combo right now, Caterpillar is a great dividend stock with tons of upside potential. But with a forward P/E ratio of just 18.7, Caterpillar is also not an expensive stock.
Caterpillar's upside comes from its exposure to oil and gas, marine transportation, rail transportation, agriculture, and mining -- all of which are industries that could be in for a multiyear up cycle. Oil and gas had a banner year in 2021 and might very well eclipse it in 2022 as the U.S. Energy Information Administration is guiding for West Texas Intermediate crude oil prices to average $97.96 in 2022 and $88.57 per barrel in 2023 compared to $68.21 in 2021 and $39.17 in 2020.
What's more, supply/demand imbalances with commodities and food are leading to higher prices, which boosts margins for Caterpillar's customers and incentivizes them to consider purchasing new equipment.
To top it all off, Caterpillar is a Dividend Aristocrat, which is an S&P 500 component that has paid and raised its dividend for at least 25 years. Caterpillar has a dividend yield of 2.1%.
Starbucks' dividend yield has risen as its stock price has fallen
Starbucks isn't typically top of mind when it comes to dividend stocks. But with a dividend yield of 2.4%, Starbucks has a higher yield than many classic dividend stocks like Procter & Gamble or Johnson & Johnson and arguably much better growth prospects.
Starbucks stock has come under pressure as investors grapple with a leadership change, inflation, unionization, and the company's decision to suspend share buybacks. Coming off its highest revenue year in company history, there's reason to believe that Starbucks' results could suffer in fiscal 2022. However, the company has plenty of positives going for it, too.
Its rewards program is stronger than ever. More and more people are mobile ordering and using its drive-thrus, which improves efficiency. And Starbucks can focus more on grab-and-go ordering by building smaller stores that focus specifically on takeout orders.
Starbucks stock is down 40% from its all-time high and hovering right around a 52-week low. And although the company has suspended share repurchases in favor of allocating capital toward the business, it hasn't shown any signs that is it going to stop raising the dividend. Starbucks began paying its dividend in 2010 and raised it every year from 2011 to 2021.
Like 3M and Caterpillar, Starbucks rakes in plenty of free cash flow (FCF) to support its dividend.
MMM Free Cash Flow Yield data by YCharts
Free cash flow yield is simply the FCF of a business divided by its market cap, or FCF per share over the share price, whereas a dividend yield is the dividend per share divided by the share price. As you can see in the chart, all three companies have an FCF yield that is higher than their dividend yield. Put another way, each company earns more FCF than it pays in dividends. This is a good sign that they can support future dividend raises. In Starbucks' case, it only uses about half of its FCF to pay its dividend, which means it has plenty of extra cash to reinvest in the business and support future raises. Starbucks also has a P/E ratio of just 21.5.
Dividend stocks at a good value
Investing in equal parts of 3M, Caterpillar, and Starbucks gives an investor an average dividend yield of 2.8%. 3M has the slowest growth and the bulkiest business, but it also is the least expensive stock of the three. Caterpillar stock has crushed the market so far in 2022, but it still looks cheap. However, investors should keep in mind that Caterpillar is coming off a record year. And as a cyclical stock, its valuation is going to look a lot cheaper in boom years and wildly expensive during down years. Starbucks is a nice blend of income, value, and growth that is likely to face a lot of short-term headaches. But its long-term investment thesis remains intact.
