The 5 Most Undervalued Stocks in the S&P 500

The S&P 500 Index is the most commonly tracked investment benchmark in the United States. When you hear about a portfolio manager “beating the market,” chances are it is in reference to outperforming the S&P 500.

The S&P 500 is also a leading indicator for domestic equities in terms of size, liquidity and diverse industry and global market exposure. Given these characteristics, it is extremely difficult to beat the market over time. This is primarily because the index is effectively a buy-and-hold fund that holds some of the largest and most competitively fierce companies in the world.

An approach that has been cited in numerous studies for consistently beating the market over time has been through focusing on companies that have above-average dividend yields. The S&P also tracks a category it refers to as the “Dividend Aristocrats,” which is a select group of firms that have been able to increase dividends for at least 25 years in a row.

The current list consists of 43 companies that qualify as dividend aristocrats, which is especially impressive given they have survived the credit crisis and been able to preserve their profits during one of the worst downturns in the economy in many decades. This group is also one of the best performing groups during the past year and the past three years, having handily outperformed the S&P 500 as well as a number of more global benchmarks.

Here are five current dividend aristocrats that stand out for their above-average dividend yields. Better yet, they stand out for their ability to be able to continue to grow profits and dividends going forward, given they are financially sound and have very compelling growth prospects across the world.

Wal-Mart (NYSE: WMT)
Business: World’s Largest Retailer
Current P/E ratio: 13.9
Current dividend yield: 2.3%

I recently concluded that Wal-Mart is the one blue-chip that every investor should own, which stems from the fact that it is one of the safest investments out there. [Read the story here] First, it is using its impressive profit generation in the United States to fund overseas growth. This strategy has allowed sales to grow at least +10% annually during the past decade.

Sales should grow in the high single digits going forward, but cost containment and other productivity enhancements should push profits up in the double digits each year going forward. Wal-Mart is also an ideal pick for investors worried about a double-dip recession or a failure of the global economy to recover fully from the credit crisis. Given its additional focus on dividends and ability to boost the payout over time, this stock pick is hard to argue against.

Abbott Labs (NYSE: ABT)
Business: Pharmaceuticals
Current P/E ratio: 15.5
Current Dividend Yield: 3.3%

Abbott is a healthcare bellwether and has a globally diversified business across a number of different product categories. In additional to pharmaceutical sales, it sells medical devices and consumer products, such as Similac baby formula. Abbot’s sights are also set overseas, and it recently announced a deal that will make it one of the largest healthcare firms in India. A low P/E, high and rising dividend yield, and double-digit growth prospects over the long haul make this an undervalued stock at current prices.

Kimberly-Clark (NYSE: KMB)
Business: Consumer Goods
Current P/E ratio: 14.0
Current Dividend Yield: 4.1%

Kimberly-Clark used to qualify as a stodgy consumer goods firm, but has become religious on controlling costs. In the past three years, it has been able to leverage modest sales growth of under +4% per year into double-digit earnings increases that have averaged nearly +12% annually. A 4.1% dividend yield also makes it one of the most generous payers out of all the dividend aristocrats. Dividend stability and improved profit growth mean Kimberly-Clark also stands out as one of the most undervalued names in the S&P 500.

Coca Cola (NYSE: KO)
Business: Beverages
Current P/E ratio: 18.7
Current Dividend Yield: 3.0%

U.S. consumers have wised up to the health drawbacks of drinking Coke’s flagship sugar water, but the namesake beverage is still growing like gangbusters overseas. Overall though, Coke is dependent on a dizzying array of other products and now boasts more than 3,300 beverages that it sells globally. Growth prospects have picked up domestically on the popularity of Coke Zero, and profits have grown almost +12% in the past decade.

Eli Lilly (NYSE: LLY)
Business: Pharmaceuticals
Current P/E ratio: 9.1
Current Dividend Yield: 5.4%

Eli Lilly has severe top-line issues to deal with in the next few years, given nearly 60% of its drug sales are subject to patent expirations during the next seven years. However, this downside is more than reflected in the stock price and is a key reason I recently pegged the stock as big pharma’s most undervalued stock. [Read my analysis here] Better yet, management has committed to keeping the current dividend yield, which is about as high as you’ll find in the S&P 500 today. This should keep the stock as a dividend aristocrat for some time, and investors have a chance for big gains by picking up the shares.

Action to Take —> Dividend paying stocks are appealing because they have a track record of beating the market. And focusing on the most undervalued names of the S&P’s dividend aristocrats means you are investing in the most undervalued names in the market today. All the firms mentioned above also offer downside protection, given their products can be considered recession-resistant. For those particularly inclined to high dividend payments, Kimberly-Clark and Eli Lilly stand out from the rest.