Do you look for value when considering different stocks? If so, here are some value ideas to keep in mind.
To illustrate, we ran a screen by starting with stocks of the S&P 500 paying dividend yields above 1% and sustainable payout ratios below 50%. We then screened these names for those that appear undervalued by two measures: levered free cash flow/enterprise value, and the Graham number.
Levered free cash flow is the free cash flow after deducting interest payments on outstanding debt. Enterprise value is the sum of the firm's value from all ownership sources: market cap, outstanding debt, and preferred shares. The higher the ratio, the more undervalued the company appears.
The Graham number was created by the "godfather of value investing," Benjamin Graham, and it represents a stock's maximum fair value. It is based on a stock's earnings per share and book value per share.
Graham number = Square Root of (22.5 x Trailing-12-Month EPS x Most-Recent-Quarter BVPS)
The equation assumes that P/E should not be higher than 15 and P/BV should not be higher than 1.5. Stocks trading well below their Graham number may be undervalued.
Business section: Investing ideas
The final list of stocks from this screen is below. These S&P 500 dividend names appear undervalued, with relatively high ratios of levered free cash flow/enterprise value. They are also trading at steep discounts to their Graham number.
Do you think these dividend stocks have more value to price in?
Use this list as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)
1. Aetna (NYSE: AET): Operates as a diversified health care benefits company in the United States. It has a market cap of $17.39 billion and is priced at $48.89 per share, with a dividend yield at 1.41% and payout ratio of 11.50%. Levered free cash flow is at $2.61 billion vs. enterprise value at $18.90 billion (which implies a LFCF/EV ratio at 13.81%). Diluted TTM earnings per share at 5.22 and a MRQ book value per share value at 28.94 implies a Graham number fair value of $58.30. Based on the stock's price at $49.62, this implies a potential upside of 17.49% from current levels.
2. Aflac (NYSE: AFL): Provides supplemental health and life insurance. It has a market cap of $20.93 billion and is priced at $43.63 per share, with a dividend yield at 2.95% and payout ratio of 29.26%. Levered free cash flow is at $2.47 billion vs. enterprise value at $22.77 billion (which implies a LFCF/EV ratio at 10.85%). Diluted TTM earnings per share at 4.18 and a MRQ book value per share value at 28.96 imply a Graham number fair value of $52.19. Based on the stock's price at $44.8, this implies a potential upside of 16.49% from current levels.
3. Travelers (NYSE: TRV): Provides various commercial and personal property and casualty insurance products and services to businesses, government units, associations, and individuals primarily in the United States. It has a market cap of $23.14 billion and is priced at $58.07 per share, with a dividend yield at 2.79% and a payout ratio of 47.31%. Levered free cash flow is at $4.09 billion vs. enterprise value at $26.01 billion (which implies a LFCF/EV ratio at 15.72%). Diluted TTM earnings per share at 3.37 and a MRQ book value per share value at 62.31 imply a Graham number fair value of $68.74. Based on the stock's price at $58.88, this implies a potential upside of 16.74% from current levels.
4. Time Warner (NYSE: TWX): Operates as a media and entertainment company in the United States and internationally. It has a market cap of $35.40 billion and is priced at $36.18 per share, with a dividend yield at 2.84% and a payout ratio of 34.73%. Levered free cash flow is at $10.80 billion vs. enterprise value at $51.59 billion (which implies a LFCF/EV ratio at 20.93%). Diluted TTM earnings per share at 2.71 and a MRQ book value per share value at 30.76 imply a Graham number fair value of $43.31. Based on the stock's price at $36.65, this implies a potential upside of 18.17% from current levels.
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
