Deep Dive: As tech companies take over the market again, don’t forget these bargain dividend stocks

This is a perfect time to be reminded that there are other approaches to the stock market. According to Daniel Genter, president of Genter Capital Management, which manages about $6 billion for institutional and private clients in Los Angeles, “what is attractive now is not to jump on that bandwagon, but to look at undervalued companies with high dividends.”

In an interview, he named AT&T Inc.
T,
+1.82%
as an example, pointing out that the stock’s forward price-to-earnings ratio is very low and that its dividend yield of more than 7% is well supported by expected cash flow. Read more about this below, where we screen the S&P 500 for stocks meeting similar criteria.

Heavyweights

If we look at the $405 billion SPFR S&P 500 ETF Trust
SPY,
+0.22%,
which tracks the benchmark index, the weighting by market capitalization is so concentrated that five companies make up more than 24% of the portfolio.

The return numbers, up and down, have been astounding.

In a May 31 note to clients, Ed Clissold and Thanh Nguyen of Ned Davis Research wrote that the “overarching theme for the stock market in 2023 is the mean reversion in mega-cap stocks that underperformed in 2022.” They added that the percentage of stocks in the S&P 500 outperforming the index was at a record low and that following similar periods of “narrow leadership,” performance of the benchmark has been relatively weak.

This isn’t to say that an investor won’t benefit from continued exposure to the S&P 500, but it underscores that a cap-weighted index of 500 stocks isn’t as diversified as you might have thought it would be.

According to NDR, the percentage of the S&P 500 allocated to the largest five companies is the highest in their records going back to 1973. Through May, 24.5% of stocks in the S&P 500 had outperformed the index, according to NDR. “If it holds through the end of the year, it would be the lowest percent outperforming the index on record,” Clissold and Nguyen wrote.

And this underscores how exposure to stocks with high dividend yields that appear to be well supported by cash flow might make it easier for investors to ride out the type of market gyration we experienced last year — while being paid to wait.

A dividend-stock screen

When discussing AT&T, Genter said the company’s valuation was attractive in part because of the “dark cloud” over the company from its history of making expensive acquisitions, many of which were unwound through spinoffs in 2021 and 2022, including the spinoff of WarnerMedia to combine it with Discovery and form Warner Bros. Discovery Inc.
WBD,
+4.04%.

Genter said the market wasn’t giving AT&T’s management credit for having learned its lesson and for positioning itself to be a stronger competitor against Verizon Communications Inc.
VZ,
+0.70%.
He also pointed to its low forward price-to-earnings ratio of 6.3. In comparison, the weighted forward P/E for the S&P 500 is 18.6, based on consensus estimates among analysts polled by FactSet.

“We are also seeing encouraging stickiness when it comes to pricing,” he said. “Some competitors have had to cut prices to maintain share, but they have been able to increase some prices.”

He said AT&T’s high dividend yield was supported by “very high free cash flow.” If you buy a stock in part because of a high dividend yield, the last thing you want to see is a dividend cut.

A company’s free cash flow (FCF) is its remaining cash flow after capital expenditures. This is money that can be used to raise dividends or to buy back shares, to expand organically or through acquisitions, or for other corporate purposes.

If we divide expected FCF per share by the current share price, we have an estimated FCF yield, which can be compared with the current dividend yield to see if there is headroom. The more headroom, the better.

For this screen, we began with the S&P 500 and narrowed the list as follows:

• We removed any company for which consensus estimates for free cash flow weren’t available for the following 12 months. This includes banks and insurers, for which different measures are typically used to gauge dividend-paying ability.

• We excluded real-estate investment trusts. In this industry, other measures, such as funds from operations and adjusted FFO, are typically used to measure dividend-paying ability.

• We excluded any remaining company for which a forward price-to-earnings ratio wasn’t available. That typically means that combined earnings for the following 12 months are expected to be negative.

These culls left a list of 331 companies. We then limited the list to companies with dividend yields of 5.5% or higher, because in the current market, you can get a yield in excess of 5% for a 12-month certificate of deposit at a bank.

Finally, we limited the list to companies with estimated FCF headroom of 1% or more, based on consensus FCF estimates for the next 12 months.

Nine companies passed the screen. Here they are, sorted by indicated FCF headroom:

AT&T leads the list, not only with the most expected FCF headroom, but with the lowest forward P/E.

Click on the tickers for more about each company, index or ETF.

Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.