2 Winning Ideas For Growth And Income

Nick Lanyi's picture

Friday, June 10, 2016 - 12:30pm

by Nick Lanyi

Some investors look for capital appreciation; others are focused more on income. But one of the smartest ways to invest is to combine both of these goals in a single stock. A growth and income strategy leads to undervalued stocks of companies that generate a lot of cash -- exactly the kind of investment favored by such legendary investors as Warren Buffett.

The problem is that the highest-quality companies rarely trade at cheap valuations. That doesn't mean they can't deliver capital appreciation; in fact, over time they often do. But you get more bang for your buck when you buy a stock at a below-average valuation. So it's useful to look for companies that are high quality but somewhat out of favor temporarily. Maybe they're in a sector that is expected to face headwinds in the near future, or they're constrained in the short run by high debt or regulatory uncertainty. Whatever the reason, their low valuation can be an opportunity to pick up shares that stand a good chance of paying off big over time.

Today, let's look at two companies that are trading at attractive valuations while also paying out generous dividend yields.

Ford Motor (NYSE: F) is one of the world's largest automobile companies. Founded by Henry Ford in 1903, the company has had its ups and downs but emerged in this century as the healthiest and most innovative of the big three U.S. auto manufacturers. That's a great position to be in today, as U.S. vehicle sales have rebounded strongly in recent years -- from 11.6 million in 2010 to 17.3 million last year -- thanks to lower unemployment, interest rates and gasoline prices.

Unlike General Motors and Chrysler, Ford did not receive a government bailout, go through bankruptcy and then rise phoenix-like in reconstituted form. Ford did respond to the Great Recession by paring back less-profitable brands and models. Ford now sells cars mainly under the Ford and Lincoln brands, and it has reduced the number of vehicle platforms it uses to produce cars from 27 in 2007 to only 12 now (with plans to decrease to eight by 2019).

Ford has been the top-selling U.S. brand for six straight years, led by its successful truck division. (The Ford F-150 has been the #1 selling vehicle in the United States for 32 years.) Many of the carmaker's models enjoy high scores from ratings services for reliability and performance, and Ford has been a leader in integrating technology into its cars. 

Car sales have lagged a bit after booming through 2015, and some experts are concerned that rising interest rates could hurt sales over the next year or two. However, it seems unlikely that sales will fall off dramatically with unemployment so low and consumer confidence rising, even if the Fed raises rates a tick or two -- especially if gasoline prices remain low.

At recent levels, Ford trades at 6.4 times analysts' consensus estimate for 2016 earnings per share. Given projections for 7% annualized earnings growth over the next few years, that's a comparatively low valuation. The stock also yields a hefty 4.5%.

AT&T (NYSE: T), one of the world's largest telecommunications companies, provides telephone and broadband service in 21 states and has more than 110 million U.S. wireless customers. Created by the merger of SBC, Pacific Telesis, Ameritrade, BellSouth and AT&T between 1997 and 2006, AT&T expanded once again -- and in some ways, most dramatically -- with the 2015 acquisition of DirectTV, making the company the largest pay-TV provider in the world.

As one of the leading providers of several essential services in growing markets, AT&T generates solid revenue growth despite its size: sales rose 11% in 2015 and should match or exceed that rate in 2016. The company is looking for especially strong growth from international operations; its Mexican mobile business is thriving and revenue could double there over the next four years. 

Thanks to smart management and the monthly checks that arrive from those millions of customers each month, AT&T generates strong cash flow. This cash stream will allow the company easily to pay down the significant debt it accrued to acquire DirectTV. The company has increased its dividend for 31 straight years, and I look for bigger dividend increases to resume in the next few years. 

AT&T currently yields a robust 4.8%, and I think the stock could move at least 10% higher in the next 12-18 months. It currently trades at a reasonable 13.9 times analysts' consensus estimate for 2016 earnings per share.

Risks To Consider: Ford is vulnerable to economic recession and faster-than-expected interest rate increases. AT&T could be hurt by regulatory decisions that lower profit margins for video providers.
    
Action To Take: Buy Ford below $15 and AT&T below $42.

Editor's Note: Everyone knows that dividend payers crush other stocks. It's not a matter of opinion. You can just look at the stats. But what's really interesting is why they do so much better. We've found the answer here.​

Nick Lanyi does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.