Companies possess high dividend yields for various reasons, some good and some bad. A high dividend yield can be a sign of a stock that is undervalued, or that the company is in financial straits—sometimes both. Still, including high dividend yields as part of a broader set of investment criteria can help investors identify investment candidates that will provide both income, an obvious result of a high dividend, and potential value.
Similarly, a low price-to-book value ratio can signal that an equity is being undervalued by the market. Like dividend yields, stocks have low price-to-book ratios for various reasons, not all of which are indicative of a worthwhile investment option. However, with thousands of stocks to examine, it can help to use a low price-to-book value ratio to cut through the clutter of options that aren’t of interest.
Combining the two criteria, we reasoned, would create an interesting mix of companies. Since there is no true cut off for what counts as a high dividend yield or a low price to book value ratio, we arbitrarily used a dividend of at least 4% and a price-to-book value ratio of  or lower. (A price to book value below 1 indicates that a company is trading below its book value.) Since both measures rely on stock prices, market conditions clearly play a role in the ultimate results that a screen such as this will produce. Subscribers can replicate this screen using the online screening tools of The Value Line Investment Survey, tailoring these criteria both to market conditions and their own personal tastes.
Companies that passed both of our screening criteria include Lorillard, Inc. (LO), STMicroelectronics (STM), and Vodafone Group (VOD).
Lorillard, Inc. is the third largest manufacturer of cigarettes in the United States. It produces five brands: Newport, Kent, True, Maverick, and Old Gold. Under these labels, it has created 43 different types of cigarettes ranging in price, flavor, taste, and length. Newport is the flagship brand and accounted for 90% of 2010 sales. Lorillard sells to distributors, which then service chain stores and other retail channels.
Business prospects at Lorillard are favorable. The company ought to experience healthy top- and bottom-line growth over the next two years for several reasons. First, a more favorable pricing environment should help lift profits. The company recently announced that it will be increasing the prices of the majority of its cigarettes, including Newport. Further, ongoing strong demand trends are evident at this juncture, since domestic shipments rose 9% during its first quarter, versus an overall market decline of 3%.
Investors should be warned that there are a number of regulatory challenges facing cigarette manufacturers, such as the FDA’s consideration of a full ban on menthol cigarettes and its mandate to include graphic anti-smoking images on packs. Lorillard is using its ample resources to ensure menthol cigarettes stay legal, and argues that "Prohibition of menthol cigarettes would lead to the illegal sale of more dangerous cigarettes through an unprecedented underground market."
Over the next two years, the company’s book value will likely be in the red, signaling some potential value. Furthermore, the high dividend yield may entice income-oriented investors looking for potential undervaluation.
STMicroelectronics is a semiconductor company that designs, develops, and manufactures a range of semiconductor integrated circuits and discrete devices. Its product portfolio consists of over 3,000 products, such as analog, digital, and mixed-signal applications as well as items, such as mobile phone accessories and in-vehicle equipment for electronic toll payment. The company services about 1,500 customers in a range of industries including auto, industrial, and telecom areas.
STM shares may be a value buy for investors. The recent stock price of $7.00 (as of 8/14/11) represents a further 26% decline since our July report. Investor sentiment is likely being soured by the lackluster second-quarter results released recently. Sales advanced modestly while earnings fell below last year’s comparable quarter and also decreased in comparison to 2011’s March period.
Management’s lackluster outlook for the third quarter is not helping either. Challenges are currently being experienced due to the company’s joint venture with ST-Ericsson. Demand for wireless products is subdued. In addition, other industries that STM relies on such as auto and industrial, continue to face adversity from weak macroeconomic conditions.
Although the stock is risky because many of its products are intrinsically tied to current volatile industries, venturesome investors may want to acknowledge the company’s above-average dividend yield. In addition, the low price-to-book ratio is an indication that the stock may be undervalued by accounting standards. Also, the company has some good growth prospects such as an active innovation pipeline of new products and expansion opportunities in the healthcare and energy management industries. These may prove to be significant catalysts further down the road.
Vodafone Group is a provider of mobile communications in Europe, Africa, the Asia Pacific, the Middle East, and the United States. The company operates in 26 countries and services about 379 million customers. In addition, VOD owns 45% of Verizon Wireless (VZ - Free Verizon Stock Report). The product portfolio is vast with goods and services that include Internet, email, music, fixed voice and fixed broadband solutions. Breakdown of 2010 revenue by region: Germany, 17%, Spain, 11% Italy, 12%, U.K., 11%, India, 8%, Other, 41%.
The phone company is experiencing some growth thanks to favorable currency translation rates and greater contributions from emerging markets, such as India and South Africa. In addition, Verizon Wireless continues to make positive strides. Demand for the iPhone is enabling Verizon to capture greater market share in the highly competitive wireless environment, and the rapid repayment of debt is an indication that Vodafone’s cash balance may well benefit from this action.
The dividend yield should be quite attractive to income-oriented investors, since it exceeds the Value Line median by a wide margin. Furthermore, the company intends to raise the dividend payments at a 7% annual rate over the next few years. As well, the low price-to-book ratio signals that the equity may be trading below its true value and, therefore, pose a good buying opportunity for speculative accounts.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.