With bond prices plummeting due to the trend of rising interest rates, many investors are swapping their bonds for high-quality stocks that have high dividend yields. Because of this, it has become hard to find value and a high yield together.
Many income investors just buy a stock for the dividend and couldn’t care less about the potential capital gains that a business will have over the next few years. This is a big mistake, even if the company is able to sustain its dividend for the next decade. If a company is unable to grow its earnings, then its cash flow is unlikely to support dividend increases going forward, and a lack of regular dividend increases can really cut into your returns over the long run.
Buying dividend stocks is no different from buying any other type of security. You have to consider the growth potential of a business, and you always need to consider the value that you’re getting from buying a stock or a bond at a particular level.
While most of the popular dividend stocks are trading at premiums these days, there is one stock that I believe is severely undervalued.
Telus Corporation (TSX:T)(NYSE:TU) pays a very bountiful 4.4% dividend yield which has the potential to grow by leaps and bounds over the next few years as the company grows its subscriber base. The stock has been flat for the last two years and could rally sharply in 2017.
When valuing dividend stocks, it’s a good idea to compare the current dividend yield with its historical average. If the dividend is significantly higher than the historical average, and there has been no detrimental news that could affect long-term earnings prospects, then the stock is undervalued and a buy.
The stock currently yields 0.4% more than its five-year historical average dividend of 4%. We are entering a rising interest rate environment, and because of this, Telus has struggled to break through the $44 level. There are no major headwinds that could hurt Telus’s earnings growth in the long run, so Telus looks like a screaming buy right now.
Telus has the best customer service of the Big Three Canadian telecoms, and I believe this is an underrated part of the business that many investors often overlook. It’s not a mystery that the telecom industry encounters many issues, ranging from choppy wireless signals to high-latency internet connections. These issues need to be addressed in the best way possible, so a customer doesn’t leave for a competitor. The telecom space is highly competitive, and if Telus is to grow, it will need to be able to keep its current subscriber base.
The stock currently trades at an 18.72 price-to-earnings multiple with a 3.1 price-to-book and a 7.7 price-to-cash flow multiple — all of which are in line with historical averages. I believe Telus has the best growth potential of the Big Three and could be ready to soar to new highs in 2017.
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Fool contributor Joey Frenette has no position in any stocks mentioned.