3 Overvalued Dividend Stocks to Avoid (and 3 to Buy Instead)

NEW YORK (TheStreet) -- In one way of looking at it, the S&P 500 is about 30% overvalued. The index's historical price-to-earnings ratio is 15.5, while its current price-to-earnings ratio is over 20.

That said, the market is made of individual stocks, some of which are still undervalued, while many are overvalued. This article features three dividend stocks that are trading at scary-high valuations. Investors should avoid these three dividend stocks until their respective valuation multiples come back down to a more reasonable level.

The three stocks in this article are all great businesses. They have long histories of rewarding shareholders and growing earnings-per-share. But this doesn't mean they are worth any amount of money one might pay. Dividend investors will do well to pay close attention to how much they are paying to own shares in a business. As Warren Buffett says, "Price is what you pay, value is what you get"

Don't overpay and get less than fair value for your money. The three stocks below are trading well above fair value.

Brown-Forman (BF.B)

Brown-Forman is the maker of Jack Daniel's, Southern Comfort, Finlandia, Canadian Mist, and Korbel and other popular spirits. The company's liquor brands are popular regardless of the economic climate. Brown-Forman is an exceptionally high quality business with a strong competitive advantage from its strong brands.

Unfortunately, the stock appears significantly overvalued at this time. Brown-Forman has a price-to-earnings ratio of 28.8, well above the S&P 500's price-to-earnings ratio. Brown-Forman's price-to-earnings ratio has nearly doubled since 2009 and yet has averaged less than 20 for 10 of the last 16 years. It is currently trading at its highest price-to-earnings ratio since 2006.

Brown-Forman's earnings-per-share growth over does not justify its lofty price-to-earnings ratio. The company has grown earnings-per-share at 8.4% a year over the last decade. These are solid results, but they come nowhere close to justifying a price-to-earnings ratio near 29. The company has a dividend yield of 1.5%. Brown-Forman is a Dividend Aristocrat and has increased its dividend payments for 31 consecutive years.

Investors can expect continued growth from the company's Jack Daniel's brand and other premium liquor brands. Analysts are expecting earnings-per-share to continue growing around 8.5% a year going forward. This growth combined with dividend payments gives investors an expected total-return of about 10% a year. If the company's valuation multiple reverts back to the high teens, current investors will see significant losses.

Yet, those looking to improve their dividend portfolio should consider other high quality beverage companies at this time, though ones that are better priced. Coca-Cola (KO) currently has a price-to-earnings ratio of 20 (nearly 30% lower than Brown-Forman's) with a dividend yield of 3.2% (more than double Brown-Forman's). Additionally, Coca-Cola is expecting 7% to 9% earnings-per-share growth and has a portfolio of 20 brands that generate $1 billion or more per year in sales.

"To me, Coca-Cola is intriguing because of the calls it has on the super-growth vehicle that is Monster and the potential home run that another company it has a stake in, Keurig Green Mountain (GMCR), might hit with its cold-drink process. Plus there's the nice 3% yield," writes Jim Cramer on Real Money

Read more about what Cramer and others have to say about . 

Church & Dwight (CHD)

Church & Dwight owns the Arm & Hammer, Trojan, OxiClean, and Vita Fusion/Lil' Cirtters vitamins brands, in addition to other, smaller brands. Church & Dwight was founded in 1846 and has paid steady or increasing dividends for 25 years.

Church & Dwight currently has a price-to-earnings ratio of 27. The company is trading near 10 year historical price-to-earnings ratio highs. Church & Dwight's lofty price-to-earnings ratio is a result of the company's success over the last several years.

The company has managed to compound earnings-per-share at a blistering 14.1% a year pace over the last decade. Growth has been fueled by several large acquisitions including OxiClean in 2006, Orajel in 2009, and VitaFusion/Lil' Critters vitamins in 2012. Church & Dwight is expected to compound earnings-per-share at about 9% a year going forward. This growth is at the high end of its peer comparison group, but is not fast enough to justify a price-to-earnings ratio of 27.

Church & Dwight is an excellent business. The company has made strategic acquisitions over the last decade that have boosted shareholder value. Church & Dwight's high quality brands give it a strong competitive advantage and stable cash flows. The company will make an excellent investment -- that is, when its price-to-earnings ratio falls closer to its historical average of 18 to 20.

Also of note, the company was just downgraded in late April by Goldman Sachs  (GS) and Oppenheimer

Read more about what Real Money authors think about CHD.

Investors building a dividend growth portfolio should look at Kimberly-Clark (KMB)for a high quality consumer goods dividend stock. Kimberly-Clark  has a price-to-earnings ratio of 19 and a dividend yield of 3.2% -- significantly higher than Church & Dwight's 1.6% dividend yield. Kimberly-Clark has increased its dividend payments for 43 consecutive years. The company has a portfolio of high quality brands that includes Kleenex, Huggies, Kotex, Scott, and Viva.

Jim Cramer recommends KMB as one of his stocks to buy here.

Lowe's (LOW)

Lowe's is the second largest home improvement store in the U.S. based on its market cap of $67 billion. The company has a long history of being very shareholder friendly. Lowe's is one of only 16 Dividend Kings; it has increased its dividend payments for 50 or more consecutive years.

Lowe's currently trades at a price-to-earnings ratio of 26. The company is trading very close to its highest price-to-earnings ratio of the last decade. Lowe's appears significantly overvalued at this time relative to its historical price-to-earnings ratio.

Lowe's is a highly cyclical stock. Since 2009, the company has been on a tear, growing earnings-per-share to $2.67 in 2014 from $1.21 in 2009. The company does well when the economy is growing as people buy homes for the first time and come to Lowe's for their home improvement supplies. When the housing market slows, Lowe's performs poorly. Interestingly, the company's price-to-earnings ratio has risen along with gains in the housing market. This has created a risky paradigm with the stock. When the housing market is growing, Lowe's sees both price-to-earnings multiple gains and earnings-per-share growth. When the opposite occurs, the company sees declines in both its price-to-earnings ratio and its earnings-per-share, significantly impairing shareholder value.

The Federal Reserve could increase interest rates in fiscal 2015, which would reduce demand for housing. This could have a material negative effect on Lowe's. In any case, the company has seen a six year bull run. When a bear market comes (and it should eventually), Lowe's shares will likely suffer more than the overall market.

Investors looking for big-box retail exposure should consider Wal-Mart (WMT) instead of Lowe's. Wal-Mart has a price-to-earnings ratio of just 15.3, a 2.5% dividend yield to go along with over 40 years of dividend increases, and a 7.5% earnings-per-share growth rate over the last decade. The combination of an above-average dividend yield, fair-or-better price-to-earnings ratio, and solid growth makes Wal-Mart a favorite of The 8 Rules of Dividend Investing. For comparison, Lowe's has grown earnings-per-share at about 5% a year over the last decade and has a dividend yield of just 1.3%.

This article is commentary by an independent contributor. At the time of publication, the author held WMT.

More from Opinion

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook