Veteran investors know it can be lucrative to buy stock in great companies that have fallen out of favor with the market. It's admittedly hard to find stocks like this that investors are completely mispricing, but they are out there. It helps to focus your search on companies with long-term growth catalysts that are dealing with short-term challenges.
Here are three dividend stocks that all have the potential to reward investors once they have navigated their current issues.
1. Citizens Financial Group
Citizens Financial Group (CFG 0.98%) is a regional bank whose stock tumbled along with the rest of its peers during the banking sector crisis earlier this year. Rising interest rates and volatile macroeconomic conditions threatened some smaller financial institutions whose balance sheets indicated heavy customer concentration in specific sectors (like tech). The crisis led to a couple of high-profile failures, including SVB Financial's Silicon Valley Bank. Contagion fears then created serious issues for the entire banking sector, both operationally and in the stock market.
Citizens Financial was among the affected banks, and it was forced to slash its revenue outlook in its April earnings report. Share prices dropped around 40% amid the macro pressure and revised forecasts.
Image source: Getty Images.
Investor concerns were warranted, but fear-driven selling ended up creating an opportunity for contrarians who wanted to buy low. Citizens Financial boasts capital ratios that are among the best in its peer group, and those ratios improved in the second quarter relative to the first. Strong capital ratios indicate a buffer for the company in the event that difficult conditions are sustained. It also puts less pressure on the bank to sell bonds at a loss to cover capital requirements.
The stock's forward dividend yield is around 6.5%, so its price implies that the dividend is likely to fall in the future. At the moment, Citizens Financial is comfortably generating enough earnings to cover the quarterly distributions -- its dividend payout ratio was under 50% last quarter.
Banking is a cyclical sector that can be highly sensitive to macroeconomic conditions. We've seen multiple major disturbances that shook up that industry over the past 15 years alone. There are serious external risks inherent when investing in regional banks, so be aware of those. If those risks are within your tolerance, Citizens Financial is worth a look to buy at an event-driven low.
2. Pfizer
Share prices of pharmaceutical giant Pfizer (PFE -1.47%) are down nearly 30% year to date as investors recalibrate their expectations in the aftermath of COVID-19. Pfizer's earnings are normalizing after the dissipation of the COVID-19 bump. In the most recent quarter, revenue dropped 53% year over year and earnings per share declined 77%, due primarily to plunging demand for COVID-19 treatments.
It's fair for the stock to pull back when it became apparent that the drivers of the past few years were only temporary, but the market might be overreacting in terms of long-term opportunity. The stock's dividend yield climbed all the way to 4.5%, which should alert investors to an opportunity.
Pfizer has already absorbed most of the balance sheet damage from falling COVID-19 treatment sales, and those products represented less than 15% of total revenue last quarter. Excluding the effects of those products, the company's sales are growing around 7% annually. The headwinds might linger for another few years, but the effects shouldn't be nearly as dramatic.
Pharmaceutical company pipelines are a hugely important indicator of future cash flows, and Pfizer's gets high marks from industry analysts. That's especially true after bolstering its oncology division with the Seagen acquisition and its new alliance with a prolific biotech venture capital firm.
Pfizer should continue to struggle with its unwinding COVID-19 business, but the company's long-term prospects are still strong. Dividend growth might be unlikely during this transitional period, but the 45% payout ratio indicates a meaningful buffer against further earnings erosion. At the moment, the company is producing more than enough cash to maintain its payout.
3. NextEra Energy
NextEra Energy (NEE 1.30%) operates a regulated electric utility network that serves nearly 6 million households and businesses in Florida. The company's NextEra Energy Resources subsidiary also holds several renewable energy generation businesses, including solar, wind, and nuclear power facilities operating in a dozen other states and Washington, D.C.
Regulated utilities stocks are popular among income investors, thanks to their predictable cash flows and stable dividends. NextEra's generation and transmission business provides the company with higher growth and wider profit margins than most of its peers. Its presence in Florida also contributes to a higher forecast growth rate compared to other utilities.
Those factors all make NextEra uniquely appealing to some investors, but it also results in the stock commanding a premium valuation. It's fairly expensive within the utilities sector relative to basically every fundamental financial metric, including revenue, forward earnings, book value, and dividends. Bargain hunters might not love that part of the story, but NextEra stock has become materially cheaper over the past year.
NEE Total Return Level data by YCharts
Adjusting for dividends, NextEra shares are down more than 20% over the past 12 months. Meanwhile, its dividend yield and forward price-to-earnings (PE) ratio have changed even more dramatically, indicating that the price shift was driven by market sentiment, rather than operational woes. The utilities sector has been down in general over that time frame -- these businesses tend to be financed heavily with debt capital, and rising interest rates can really cause cash flows to deteriorate.
Investors looking for a potential industry leader in the utilities sector should consider NextEra, now that it's priced more reasonably relative to key financial metrics.
SVB Financial provides credit and banking services to The Motley Fool. Ryan Downie has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends NextEra Energy and Pfizer. The Motley Fool has a disclosure policy.
