I believe that inflation for a common man is higher than what the headline inflation data suggests. To retain purchasing power of money, it’s important to invest in asset classes that help in comfortably beating inflation. Within equities, it’s a good idea to invest in dividend stocks that offer an attractive yield. Besides regular cash flows, relatively low risk and steady capital appreciation are the positives. My target is to look for undervalued stocks with dividend yield of 5% or more for high total returns.
An important point to note is that even blue-chip stocks can trade at a valuation gap. Stocks are subject to overreaction on the downside and on the upside. It’s important to identify these blue-chip dividend stocks as they can consistently beat index returns once sentiments turn bullish.
This column discusses three undervalued dividend stocks that are worth holding. In my view, the CAGR of total returns from these stocks over the next five years will be higher than the index returns.
Rio Tinto (RIO)
Rio Tinto (NYSE:RIO) stock seems deeply undervalued at a forward price-earnings ratio of 8.5. Further, RIO stock offers a dividend yield of 5.5%. It’s worth noting that the stock has been marginally lower for year-to-date. A breakout rally might be on the cards considering the valuations.
An important point to note is that macroeconomic headwinds can potentially imply sluggish demand for commodities. However, this factor is discounted in the stock. I further believe that fiscal and monetary expansionary policies are due in 2024. This is likely to support upside for commodities. It’s therefore a good time to consider exposure to RIO stock for high total returns.
I also like the fact that Rio has strong fundamentals with an investment grade balance sheet. Further, even with weakness in commodities, the company reported operating cash flow of $6.9 billion for the first half of 2023. Robust cash flows provide high flexibility to making capital investments towards portfolio diversification. With focus on energy transition metals, Rio is likely to be a value creator.
Altria (NYSE:MO) is another undervalued dividend stock to buy. MO stock trades at a forward price-earnings ratio of 8.1 and offers an attractive dividend yield of 9.76%. I believe that MO stock is likely to deliver high total returns in the next few years.
One reason for depressed valuations is the fact that the company’s smokable segment has witnessed de-growth. That’s however a part of the company’s strategy to increase focus on the non-smokable segment.
There are two major positives to note. First, even with the business transformation underway, the smokable business is the cash flow machine. Altria has high financial flexibility for organic and acquisition driven growth in the non-smokable business.
Further, there are positive results in the non-smokable segment. As an example, the company continues to gain market share in the oral tobacco segment. Therefore, the valuations indicate stock overreaction on the downside.
AT&T (NYSE:T) stock has remained depressed for an extended period even with positive business developments. A forward price-earnings ratio of 6.3 indicates gross undervaluation and I would expect a big reversal rally in the coming quarters. Further, T stock offers an attractive dividend yield of 7.2% and dividends are sustainable even with the deleveraging factor.
To put things into perspective, AT&T reported free cash flow of $10.4 billion for year-to-date. With positive business metrics (subscriber growth), I expect cash flows to swell in the coming years. This will support deleveraging and dividends.
It’s worth noting that between 2018 and 2022, AT&T has invested $140 billion in the wire-line and wireless network. This will yield results in the form of sustained subscriber growth and potential growth in average revenue per user. Further, with major capital investments done, credit metrics will improve. This will have a positive impact on T stock. If you are looking for undervalued stocks with dividend yield of 5% start here.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.