Buy high or buy low? Probably the best answer is to do both -- depending on the unit of measure.
Buying stocks with relatively high dividend yields can prove to be a really smart move over the long term. Over the last 10 years, nearly 30% of the total return generated by the S&P 500 index came from reinvesting dividends. Over the last 80 years, the level jumps to more than 40%.
Buying low can work well, too, with respect to valuation. There's a pretty good correlation between returns over a 10-year period and stock valuation.
I like the idea of combining these approaches by buying stocks with strong dividend yields and bargain valuations. What are some dividend stocks that you can buy on sale right now? I'd put AbbVie (ABBV 1.06%), AT&T (T 0.06%), and Cummins (CMI 0.77%) at the top of the list.
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1. AbbVie
AbbVie claims one of the best dividends in the healthcare sector. Its yield currently stands at 3.93%. The drugmaker has an exceptionally strong track record of dividend increases, boosting its dividend by 140% since being spun off from Abbott Labs in 2013.
The pharma stock also ranks as one of the best healthcare bargains. AbbVie shares trade at less than 11 times expected earnings. The stock hasn't performed well so far in 2018 in part because of investors' concerns about the possibility of changes that could allow biosimilars to reach the market more quickly and eliminate the rebates paid by drugmakers to payers.
But AbbVie CEO Rick Gonzalez thinks those worries are overblown. Gonzalez stated in the company's Q2 earnings call that there were "probably more positives than negatives" for AbbVie related to changes proposed by the Trump administration. He also noted that AbbVie's top-selling drug, Humira, has competed very well in countries where there are no drug rebates.
Humira has been the primary driver of AbbVie's success in recent years. However, the company also has a couple of fast-rising stars: cancer drug Imbruvica and hepatitis C drug Mavyret. In addition, market research firm EvaluatePharma ranked AbbVie's pipeline No. 2 in the biopharmaceutical industry on the strength of potential blockbuster candidates like immunology drugsrisankizumab and upadacitinib.
2. AT&T
AT&T boasts a juicy dividend yield of more than 6%. The telecommunications giant has increased its dividend for 34 consecutive years, making the company part of the elite group of Dividend Aristocrats.
The telecom stock is also really inexpensive right now, with shares trading at nine times expected earnings and only 6.4 times trailing-12-month earnings. Merrill Lynch , noting that the stock was then the cheapest it had been in 20 years based on its P/E multiple.
There are some reasons behind AT&T's bargain price. The company's second-quarter update wasn't very impressive. The U.S. Department of Justice (DOJ) is appealing a federal judge's decision allowing A&T to merge with Time Warner. And AT&T has a huge debt load of more than $190 billion.
But AT&T should profit as it rolls out high-speed 5G wireless networks that support lots of new applications. The company should be able to reduce its debt over time. And some observers think the DOJ's chances of winning the appeal are pretty slim. All in all, I think AT&T should be able to grow and continue paying its solid dividend well into the future.
3. Cummins
Global engine manufacturer Cummins doesn't have a long streak of dividend hikes like AT&T does. However, Cummins has increased its dividend by a whopping 551% since 2010. The dividend currently yields 3.18%.
Cummins CEOTom Linebarger thinks his company's stock is "significantly undervalued." I think he's right. Cummins trades at less than 10 times expected earnings. The company likes this attractive valuation so much that it's accelerating stock buybacks.
The primary factors causing Cummins stock to be priced at a discount are the company's product recalls. Cummins is recalling around 232,000 Dodge Ram truck engines and recently announced another recall of 500,000 trucks. All of these recalls relate to emissions-control system problems.
Still, Cummins is firing on all cylinders financially. The company reported all-time high revenue in the second quarter. It's expecting significant year-over-year revenue growth for full-year 2018. Cummins is also expanding into new areas such as powertrains. I think this stock -- and its great dividends -- will keep on trucking for a long time to come.
Best pick
Which of these bargain dividend stocks is the best pick for investors? AT&T has the highest yield and the lowest valuation. However, I think that AbbVie could generate the highest total returns for investors because of its growth prospects.
Wall Street analysts project that AT&T will grow its earnings by an average annual rate of 6.2% over the next five years. They think Cummins will increase its earnings by 11.7% annually. But AbbVie's earnings are expected to grow more than 16% on average each year. This growth advantage, combined with its strong dividend yield, gives AbbVie an edge over AT&T and Cummins.
Are the Wall Street growth estimates for AbbVie overly optimistic? I don't think so. Even though the company faces biosimilar competition for Humira in Europe later this year, the drug will continue to rake in enormous amounts of cash for years. AbbVie's other current drugs and its very promising pipeline candidates should enable the company to deliver on growth expectations.
Buying stocks with high dividend yields and low valuations is a smart move for long-term investors. But I think that buying stocks that also have high earnings growth prospects -- like AbbVie -- is even smarter.
Keith Speights owns shares of AbbVie and has performed consulting services in the past for Abbott Labs. The Motley Fool owns shares of and recommends Cummins. The Motley Fool has a disclosure policy.
