Source: Flickr user Andrew Magill.
Dividend stocks are the cornerstone of many well-run retirement portfolios -- that's a fact. The reason is that dividends act as a beacon to investors, inviting them to take a deeper look into a company whose business model is so sound it can pay out a percentage of its annual profits on a regular basis to its investors.
Further, dividends can provide a downside hedge in volatile and bear markets. Investors in dividend stocks tend to be more oriented toward the long term, which usually means far less day trading and volatility.
Lastly, dividends can be reinvested, giving the buyer a chance to compound their gains over the long run. These payouts can mean the difference between simply retiring and retiring the way you've always dreamed.
With that in mind, let's have a look at three cheap dividend stocks you should consider buying right now.
1. Philip Morris International (PM 0.68%)
I might come down as particularly critical of the tobacco sector, but for long-term investors looking for a cheap dividend-income stock Philip Morris International is certainly worth a look.
Within the U.S. the tobacco industry is facing some very tough challenges. Educating the public on many levels about the dangers of smoking tobacco coupled with strict regulations governing the industry have pushed cigarette prices higher and adult smoking records to an all-time record low. According to the Centers for Disease Control and Prevention just 42.1 million adults in the U.S. (17.8%) are now smokers compared to 42% of the adult population five decades ago. Furthermore, the same CDC report also showed that heavy smokers are smoking less. The end result has been a steady decline in cigarette volumes for many tobacco producers.
Source: Flickr user Asim Bijarani.
This is where Philip Morris comes in. Philip Morris operates in more than 100 countries outside the United States. While it does encounter some countries with even stricter tobacco legislation than the U.S., it also can counteract these slow-growth regions with countries like India and China where a growing middle-class looking for simple luxuries has turned to tobacco in increasingly high numbers. To put it another way, Philip Morris' geographic diversity makes strict tobacco legislation in a handful companies a moot point.
Wall Street hasn't been too kind to Philip Morris shares over the past year, and you only have to look at its latest quarterly results to see why. In the third quarter Philip Morris announced that sales dropped 0.9% to $7.9 billion, while EPS fell 4.2% to $1.38. Dig deeper, though, and you'll note that the business model and pricing power behind its premium Marlboro brand is as strong as ever. The only reason the headline number fell was because of the strength of the U.S. dollar and currency translation. Remove these currency fluctuations and the company grew EPS by nearly 10% and revenue by 4%.
At just 17 times forward earnings and with a dividend yield of 4.8% this is beginning to look like a smoking hot deal to me.
2. Fifth Third Bancorp (FITB 0.35%)
We're more than five years removed from the Great Recession, but Wall Street and investors still aren't in a forgiving mood with banks, including Fifth Third Bancorp, a 1,300-branch operator in around a dozen U.S. states.
Source: Flickr user Nicholas Eckhart.
Fifth Third is facing a number of challenges, but none sits higher than the near-record-low lending rates which constrain its interest income and investment profitability. In Fifth Third's fourth-quarter results, announced just last week, the company noted that its net interest margin fell a whopping 25 basis points to 2.96% year over year, while its net profit declined $21 million to $362 million from Q4 2013. However, EPS was unchanged due to hefty share buybacks.
Yet, in spite of these relatively familiar struggles among all banks, investors also observed some signs of strength in Fifth Third's quarterly results, particularly as it relates to cost savings and traditional banking growth.
In total, non-interest expenses fell $71 million, or 7%, from the prior-year period as a result of a 6% reduction in salaries, wages, and bonuses, and a 16% reduction in "other noninterest expenses," which included litigation fees. Although it's important to understand that cost-cutting is only a short-term fix for growth, this expense reduction came at a perfect time considering its tightening net interest margin.
Source: Flickr user MyFuture.com.
More importantly, we're seeing strength in customer deposits and loans, as well as in select aspects of credit quality. Demand deposits rose an impressive 8% year over year to $33.3 billion, while commercial and industrial loans improved 6% from Q4 2013 to $41.3 billion. Consumer loans also improved, but to a lesser degree of 1% year over year. Nonperforming assets (a common measure of credit quality) fell six basis points to 0.82% from the sequential third quarter.
All told, we're looking at a bank valued at less than 10 times forward earnings and which is paying out a nearly 3% dividend yield. That's a cheap dividend stock if I've ever seen one!
3. Two Harbors Investment (TWO 1.02%)
Lastly, I'm going to stick with the financial sector and point your attention to a true high-yield dividend stock in Two Harbors Investment.
Two Harbors is a mortgage real estate investment trust, or mREIT. As a REIT it's responsible for returning a minimum of 90% of its profits back to shareholders in the form of a dividend in return for paying less in taxes at the end of the year.
Generally, mREITs fall into two categories: agency or non-agency. Agency mREITs invest only in securities that are backed by the government. This means they're covered in case of default, but given this security they also have lower yields. It often means agency-only companies tend to lever-up in order to effect substantial profits. The other type of mREIT is one that invests in non-agency assets which that aren't covered by the government. The upside of non-agency assets is a higher potential yield, but of course the added risk of default falling back on the asset holder.
Source: Two Harbors Investment.
Two Harbors falls into this latter category, with $10.4 billion of agency residential mortgage-backed securities and $3.9 billion in non-agency RMBSs. The advantage of this dual approach is it can wind up generating much higher yields than many of its peers. Yet, a majority of its non-secured loans are senior bonds, putting Two Harbors in line to be the first payee assuming something were to happen with its investment.
Two Harbors also has a relatively tame debt-to-equity ratio as of the third quarter of just 2.9 to one. Part of this has to do with it needing to be more cautious with its non-agency portfolio, but it also a reminder that Two Harbors' risk profile could actually be favorable compared to other mREITs.
With a trailing P/E of eight and a dividend yield of 10.3% I'd opine that this could be a surprisingly cheap dividend stock for 2015 and beyond. But, it's important to note that rising interest rates could have the effect of tightening net interest margin spreads for mREITs and making their assets look less attractive. In other words, this 10% yield could fall a bit from where it's currently at; but even then I anticipate its yield will handily outpace the average yield for the overall market
