The S&P 500 currently has a price-to-earnings ratio of 25.0 and a dividend yield of just 2.0%. These are hardly appealing numbers for investors. Businesses with reasonably high yields, strong historical dividend growth, and fair (or better) valuations are getting harder to find.
This article takes a look at three high-quality dividend growth machines that appear to be undervalued at current prices -- despite the increasingly silly market levels.
Each of these businesses ranks very highly using the quantitatively based 8 Rules of Dividend Investing, which identify high quality dividend growth stocks trading at fair or better prices.
And it's easy to see why these stocks rank so well: All three of these businesses have paid steady or increasing dividends for at least 25 years. All three have dividend yields over 3%. And best of all, all three have price-to-earnings ratios under 17 (one is below 12).
Keep reading this article to learn more about these three bargains too many investors are overlooking.
Targetis the third-largest discount retailer in the United States based on its $44.33 billion market cap. Only Walmart and Costco are larger.
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Target has paid 196 quarterly dividends in a row, and today offers an attractive 3.2% dividend yield. The company hiked its dividend payments 7.1% in June.
The company is a Dividend Aristocrat, having raised its dividend for 45 consecutive years. Dividend Aristocrats are S&P 500 businesses with 25 or more years of consecutive dividend increases. You can see all 50 Dividend Aristocrats here.
In a highly competitive industry, Target has proven to be a model of consistency, with a long track record of surviving many challenges that have come its way.
Target has been very resilient the past few years. In 2013, hackers stole information on 70 million Target shoppers that holiday shopping season. This turned into a public relations nightmare for Target, which caused sales to decline for several quarters into the following year.
Then, Target spent heavily to try to mimic the success that close competitor Walmart Stores has had in Canada. But after seeing some initial success, Target had to resort to deep discounting to keep shoppers coming into stores. This caused Target to lose $2 billion in Canada before the company closed all of its stores there.
And yet, Target stands strong today. The stock price is up 3.7% year-to-date, and the company has found success once again.
In 2015, Target increased its comparable-store sales -- which shows growth rates at locations open at least one year -- by 2%. This helped to spur 11% growth in adjusted earnings per share.
Target has done well to start 2016. Comparable sales increased 1.2% in the first quarter, which resulted in 16% adjusted earnings growth.
One factor helping Target continue to grow in a difficult climate for retail is its growth in e-commerce. It is critical for bricks-and-mortar retailers like Target to adapt to consumer demands for convenience and low prices, which explains the boom in Internet retail over the past few years.
Target has responded by building its own e-commerce platform. For example, e-commerce sales jumped 34% in the fourth quarter of 2015, and by another 23% last quarter.
The stock trades for an attractive valuation, with a price-to-earnings ratio of 14.0. Target's low valuation relative to the S&P 500 -- which is trading for a price-to-earnings ratio of 25.0- - is not reflective of the company's recent growth and long history of rising dividends.
Cumminsstock looks very attractive for value investors. It trades for a trailing and forward price-to-earnings ratio of 16.2 and 15.6, respectively. This is far cheaper than the market averages.
And Cummins offers a 3.3% dividend, along with regular dividend growth. It recently increased its dividend by 5%.
The reason for Cummins' cheap valuation is that it is caught in the commodities downturn over the past two years. Cummins manufactures diesel and natural gas engines, along with related technologies, including fuel systems, emission solutions, and electrical power generation systems.
Because of this exposure, Cummins' revenue fell 10% last quarter, and the company reduced its guidance for the remainder of 2016. Management now expects full-year revenue to decline 8%-to-10% in 2016. This compares to the previous forecast which called for a more modest 5%-to-9% decline in revenue.
Cummins is seeing broad-based weakness across its key operating markets. Revenue fell 13% in North America last quarter, driven by lower truck production. Sales declined 4% in the international markets, due to worsening demand for off-highway and power generation equipment.
The international conditions are compounded by the strengthening U.S. dollar, which erodes revenue generated overseas.
The good news is that Cummins remains a strong company and a leader in its industry. Cummins is a large and highly profitable business. It operates in 190 countries around the world. Last year, the company earned $1.4 billion in profit, on sales of $19.1 billion.
Cummins is consistently profitable, which the company uses to reward shareholders. It has returned $1 billion so far this year in dividends and share repurchases. While the near-term may continue to be challenging for Cummins, it is a cheap stock that pays investors well to be patient.
The company has a long history of success. Cummins is the global leader in diesel engine manufacturing. It's usually a good idea to pick up industry leaders while they are cheap.
Additionally, the company has paid steady or increasing dividends for 25 consecutive years and compounded its dividend payments at 30% a year over the last decade.
Phillips 66 is a rare example of an oil stock actually benefiting from the decline in oil prices. As the price of oil collapsed from over $100 per barrel to the current level of $40 per barrel, it has taken a wide range of energy stocks down along with it...
But not Phillips 66, because it is an oil refiner. This differs from other oil companies, which are reliant on a high commodity price. As a refiner, Phillips 66 actually reaps higher profit margins from falling oil prices, because it reduces feedstock costs.
This is why Phillips 66 managed 11% earnings growth last year, in one of the worst years for the oil market in recent memory. The company's earnings are correlated with crack spreads, not oil prices. This gives the company a different investing profile than upstream oil businesses.
The company has been given a vote of approval by none other than Warren Buffett. Berkshire Hathaway has been loading up on shares of Phillips 66. The company is currently one of Buffett's 20 highest yielding dividend stocks, and makes up over 5.1% of Berkshire's stock portfolio.
Because of its excellent earnings growth, the stock could be considered very cheap. Shares of Phillips 66 have lost 2% of their value in the past one year, even though it has generated excellent earnings growth.
Indeed, Phillips 66 looks undervalued. In the past 12 months, the company has earned $5.78 per share in earnings. This means the stock trades for a price-to-earnings ratio of 13.
The company's low valuation does not reflect its strength. Phillips 66 is the largest refiner in the United States based on its $41.45 billion market cap. In addition, Phillips 66 owns midstream assets through its partial ownership of Phillips 66 Partners PSXP and a sizeable chemical business through its 50% ownership of CP Chemical.
Plus, Phillips 66 offers a hefty 3.3% dividend yield, and has aggressively raised its dividend in the past several years, as a reflection of its solid business performance.
Phillips 66 increased its dividend by 13% in 2016, and has raised its dividend six times since its initial public offering four years ago. Phillips 66 states it has increased its dividend by 33% on average, each year in that time. Counting its time with ConcoPhillips COP (pre spinoff), the company has paid steady or increasing dividends for 29 consecutive years.
This article is commentary by an independent contributor. At the time of publication, the author held positions in TGT, WMT, and CMI.