Inside the Numbers: Finding Value for Dividend Lovers

Everyone likes a good stock tip: a hot new Internet company, a disruptive technology, an acquisition rumor — anything that gets the adrenaline pumping. This type of hearsay-based buying and selling can net investors a buck or two now and then, but rest assured, someone already knows what you know and has already made their move.

The reality is that there simply aren’t many shortcuts for individual investors. Most of the time, the path to positive returns winds through doing your homework and crunching the numbers.

Luckily, number-crunching is one of our specialties at StreetAuthority.

For investors who’ve read Inside the Numbers in the past, you’ve probably noticed that a certain ratio is used in many of our screens. There’s a reason for that. Without a doubt, it’s one of the easiest ways of measuring a company’s true value.

It’s called the PEG ratio.

On its face, a basic price-to-earnings ratio (P/E) can’t tell you what a PEG ratio can. P/E ratios are useful in the right context: usually for comparing a stock to its historical valuation, its peers or the broader market. But for my money, the PEG is superior in a lot of ways.

For those unfamiliar with PEGs, the calculation is fairly simple. You take a stock’s P/E ratio and divide it by the stock’s earnings growth estimate:

PEG = P/E / Estimated Long-term Growth

The beauty of this calculation is that it makes it possible to find the best of both worlds: an undervalued stock with a strong growth outlook.

#-ad_banner-#There’s only one flaw with this calculation: it doesn’t account for dividend yields. And for an income investor looking for a combination of reasonable growth and income, unfortunately, PEG just doesn’t cut it.

Luckily, we can fix that with a minor tweak: the PEGY ratio.

Here’s how it works:

PEGY = P/E / Estimated Long-term Growth + Yield

It’s that simple. Say you have a stock with a P/E of 10, a long-term growth estimate of +15% and a yield of 5.0%. This means the stock has a PEGY of 0.5. As with regular PEG, any value under 1.0 is worth looking at. In this case, a value of 0.5 is extremely compelling.

With these factors in mind, I recently asked the StreetAuthority research team to look for undervalued growth/yield value stocks with the following criteria:

  • Traded in the United States
  • Market cap of at least $250 million
  • Positive trailing twelve-month earnings per share (EPS) (to ensure profitability)
  • PEGY below 1.0
  • Dividend yield beating the S&P 500’s average of 1.8%

Here’s what turned up:

Company Name (Ticker) Industry PEGY PEG P/E Dividend Yield
Diamond Offshore
Oil/Gas 0.31 0.51 9.0 8.1%
Hudson City
(Nasdaq: HCBK)
S&L/Thrift Bank 0.56 0.64 13.0 6.4%
PP&L Corp. (NYSE: PPL) Electric-Integrated 0.91 0.76 14.6 4.3%
Principal Financial
Life/Health Insurance 0.75 0.84 10.9 2.1%
Assurant Inc. (NYSE: AIZ) Multi-line Insurance 0.77 0.86 8.8 2.0%
Aflac (NYSE: AFL) Life/Health Insurance 0.80 0.84 11.4 2.4%
Allstate (NYSE: ALL) Multi-line Insurance 0.82 0.91 9.5 2.7%
Whirlpool Corp.
Appliances 0.84 0.90 13.9 2.1%

When we talked about commodity bargains last week, Diamond Offshore (NYSE: DO), was at the top of my list. The very next day, President Obama announced plans to open 480,000 square miles of costal waters for offshore oil exploration. Offshore drilling stocks (Diamond included) jumped and, thanks to rising oil prices, have rallied since then. (To read my analysis of Diamond, click here).

Hudson City Bancorp (Nasdaq: HCBK), the largest savings and loan bank in the United States, merits further investigation as well. In July last year, I called Hudson City “The Best-Managed Bank in America.”

Hudson City steered clear of the worst of the financial crisis by focusing on what it does best: writing “jumbo” mortgages for wealthy customers with low credit risk. A full 98% of its loans are secured by first liens, meaning it has first claim to the property should the mortgage holder default. Less than 2% of its loans are noncurrent, or haven’t been paid in the last 90 days.

Hudson City stayed away from subprime mortgages, car loans and credit cards — it also took zero TARP money during the credit crisis. And for this commendable performance, shares rallied more than +60% after plunging to the $8.50 range in March 2009. That still leaves the stock off the $18 to $20 a share price tag it commanded in 2008. Hudson City has remained relatively flat during the overall market’s recent rally, but could regain its previous levels once stability returns to the overall housing market. In the meantime, income investors can enjoy Hudson City’s respectable 4.0% dividend yield.