The start to 2016 has been a bit of a roller coaster. Investors were expecting interest rates to climb this year, which led to a big 10% dip at the beginning of the year. But since interest rates have fallen still further (10-year Treasury yields are down about 40 basis points), investors have piled back into stocks, putting the S&P 500 back in the black.
Dividend stocks have performed exceedingly well as investors search for yield, which makes finding undervalued and high-yielding dividend stocks more difficult today than it was just a few months ago. If you dig deep enough, there are still some undervalued dividends that you can buy right now. Here are three stocks that I think represent a good opportunity for both dividend growth and price appreciation.
1. Emerson Electric
Despite a strong start to 2016 that's seen Emerson Electric's (NYSE:EMR) stock rise around 14%, shares are still changing hands about 11% below their 52-week high. As such, the stock still offers an attractive 3.5% yield.
Emerson faces some near-term headwinds from foreign-exchange rates and a poor macro environment for the industrial automation industry. Despite industry pressure in the first quarter of the year, Emerson stock has rallied nonetheless. And while investors shouldn't expect the rally to continue at this pace (though it could depending on how well the industry rebounds in the second half of 2016), right now presents an excellent long-term buying opportunity for Emerson.
Emerson is undergoing a significant restructuring. It's looking to sell off its network power segment, which is growing more slowly than expected. It also has plans to sell the motor and drives and power generation divisions. Getting rid of those assets will result in a company with lower revenue but higher margins. The move will also provide cash for bolt-on acquisitions CEO David Farr wants to pursue, or to increase its dividend.
The dividend payout is just 60% of last year's earnings. That leaves a lot of room for management to continue raising the dividend even though analysts are pessimistic about its earnings potential. The consensus expectation is earnings of just $3.05 per share. Still, the current dividend is just 62% of that expectation. More importantly, analysts expect Emerson to grow earnings an average of 5.6% over the next five years, which should translate into dividend growth.
2. Wells Fargo
Wells Fargo (NYSE:WFC) just increased its dividend for the fifth straight year. It was just a couple of pennies, 1%, but it represents management's commitment to growing its dividend and returning more capital to shareholders. The stock now yields about 3%. As a bank, the company requires regulatory approval for its capital return program each year, but it appears to have room to grow its dividend as a percentage of earnings.
Management agrees. When asked about the importance of raising the company's dividend, CEO John Strumpf told analysts "Well, surely, it's important. This is not our money, it's our investors' money. ... We have been disciplined about stepping up and probably pushing the envelope a bit on getting the returns to our shareholders."
Going forward, higher interest rates should lead to higher net income for Wells Fargo. With the Federal Reserve expected to raise rates at some point this year, there's still time for investors to get in on the stock.
Keep in mind that Wells Fargo acts as more of a hedge in a dividend portfolio. As interest rates increase, the company performs better while most dividend stocks fall, as investors are more easily able to find yield elsewhere.
The company's current dividend payout is just 37% of analysts' consensus 2016 earnings estimate. Combined with its share repurchase plans, it's only returning about 61%. Management believes it can return as much as 79% of earnings to shareholders. An expected increase in earnings along with plans to payout a higher percentage of those earnings means investors can expect strong dividend growth going forward.
While the PC market is shrinking, Microsoft (NASDAQ:MSFT) remains a strong tech company. CEO Satya Nadella is reducing the company's dependence on PCs, focusing on cloud and mobile first. The stock yields about 2.8%, and management has increased the dividend an average of 17.6% annually the past five years.
While Windows sales will probably continue to decline going forward, Microsoft's Azure represents the perfect hedge against PC software sales. It's the second-largest cloud platform after Amazon.com, and the division grew 120% year over year last quarter. Meanwhile, Microsoft has successfully transitioned a large portion of its Office business to the cloud. It now has 20 million consumer licenses for Office 365, and commercial licenses increased 57% last quarter.
Windows 10 is off to a strong start. It's already installed on over 270 million machines. The company is still planning on 1 billion active devices with Windows 10 by 2018. While many of those Windows licenses are free, Windows 10 is aimed at driving use of its cloud services (Bing, Office 365) and software sales in the Windows Store. The unified OS is also Nadella's plan to take a bigger role of the smartphone and tablet markets.
Its payout ratio sits at 54%, but with solid cash flows and the potential for earnings improvements from the cloud, Microsoft could continue increasing its dividend for years to come. It might not be at an average of 17.6%, but with analysts expecting earnings growth to average 8.7% over the next five years, Microsoft could safely increase its dividend at the same rate while still investing in growth.