Investors looking to pad their passive-income streams have some interesting options right now. The two stocks in this article have been beaten down to valuations that seem too low, given the strength of their underlying businesses.
When bought on the dips, stodgy old dividend businesses like these two can produce market-beating gains that make growth-stock investors envious. To produce big returns, though, businesses need to significantly raise their payouts over time.
Investors could jump on these seemingly underpriced dividend stocks simply because they've been beaten down. Instead, have a look below at the opportunities and challenges they're facing so you can gauge their chances of delivering outsized gains.
CVS Health
CVS Health (CVS -0.22%) is famous for its ubiquitous chain of retail pharmacies, but savvy investors know that this is a shrinking part of the healthcare company's overall operation. For years, it has earned more money by running America's largest pharmacy benefits management business. Since acquiring Aetna in 2018, the company is also one of the country's largest managers of health insurance benefits.
Shares of CVS Health recently took a beating in response to news that Blue Shield of California would expand the list of pharmacy benefits managers it partners with to five. As a result, CVS Health will take a smaller role -- likely limited to specialty pharmacy services from Blue Shield's 4.8 million members.
Blue Shield is responsible for a small but significant portion of CVS Health's overall pharmacy benefits management business, which had more than 110 million members at the end of June. On its own, this loss will hardly register on the company's income statements. That said, investors want to keep an eye open for more large organizations following suit.
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The Blue Shield announcement pushed CVS Health stock down to a shockingly low price of just 4.9x trailing free cash flow. If the company's bottom line simply holds steady, long-term investors who buy at this level can realize market-beating gains.
CVS Health shares offer a 3.6% yield at recent prices, and investors can reasonably look forward to rapidly increasing payouts. The company needed just 17% of the free cash flow its operations generated over the past year to meet its dividend commitment.
The company's pharmacy benefits management business could backslide, but its managed-care business, Aetna, still collects monthly premiums from around 36 million people. Unlike many of its smaller peers, CVS Health can directly provide many of the benefits it gets paid to manage.
The recent acquisition of Signify Health gives CVS Health a network of more than 10,000 clinicians who can connect with millions of patients in their homes annually, and this is just the beginning. The company operates 177 primary care medical clinics, plus more than 1,100 walk-in clinics within its chain of retail pharmacies.
AT&T
Shares of AT&T (T 1.02%) are down 22% this year and offer a tempting 7.8% yield at recent prices. Whenever you see a dividend yield this high, it's because the market has concerns about the company's ability to maintain and raise its payout. In this stock's case, though, the concerns appear overblown.
It isn't unusual for customers to keep the same mobile service or internet service provider for more than a decade. For businesses that increasingly rely on connectivity, switching services comes at a significant cost. For many, there aren't any viable options to begin with.
An enviable position allowed AT&T to add 250,000 net new fiber internet subscribers in the second quarter. It was the 14th consecutive quarter with at least 200,000 net new additions.
Steadily rising subscriber revenue helped AT&T generate $18.2 billion in free cash flow, and the company needed less than half of this sum to meet its dividend obligation. That means there's room for modest but steady payout raises in the years ahead.
Putting some shares of this stock in a well-diversified portfolio now looks like a smart move for income-seeking investors.
