When it comes to selecting the best dividend stocks, an approach worth exploring is focusing on undervalued high-yield stocks. It’s easy to conflate a high dividend yield with a low valuation, but this is often not true.
In fact, numerous high-yielding dividend stocks are arguably overvalued, as investors price them based on the size of their payouts, as opposed to relative to their earnings. A good example is PetMed Express (NASDAQ:PETS).
A big reason why PETS stock trades at a high valuation (28.75 times forward earnings) is due to its 8.52% dividend. Overvalued high-yield names like PETS can be profitable investments as long as the dividends keep coming.
However, if companies like this are forced to slash dividends, they can experience sharp declines in price. Hence, it’s best to consider them “dividend traps” to avoid.
On the other hand, with undervalued high-yield stocks, their respective low valuations can provide downside protection in case of a dividend cut and an additional way to generate returns (if they bridge the gap between trading price and underlying value).
Below are seven stocks that offer this strong combination of a low valuation and a high dividend.
Algonquin Power & Utilities (AQN)
Algonquin Power & Utilities (NYSE:AQN) is one of the high-yield stocks to buy for reasons beyond just the criteria we set above. The Canada-based renewable energy and utility company is not only an undervalued high-yielder, with a forward earnings multiple of 14.6x and an annual dividend yield of 5.24%.
AQN stock also has an activist investor catalyst. Recently, Starboard Value purchased a 7.5% stake in the company. The fund (with a strong activist investing track record) has already started to push for changes that may maximize shareholder value.
One of Starboard’s key recommendations is for the company to sell its unregulated renewables business. Per the fund, doing this will de-lever Algonquin’s balance sheet, protecting its high payout. This move could also boost the price of AQN, as the company would once again become primarily a regulated utility. Regulated utilities trade at valuations higher than AQN’s current multiple.
Vaalco Energy (EGY)
A big reason why I consider Vaalco Energy (NYSE:EGY) one of the best penny stocks is due to its status as one of the undervalued high-yield stocks. Even among independent energy exploration and production (or E&P) names (which typically trade at low multiples), Vaalco is undervalued.
EGY stock trades for less than five times forward earnings. Comparable names have forward multiples in the mid-to-high single digits. Earlier this year, Vaalco increased its dividend payout to 6.25 cents per quarter. This gives EGY an annual payout of 25 cents per share for an annualized yield of 5.92%.
That’s not all. If energy prices hold steady, there’s big upside potential for shares if crude oil prices keep bouncing back. Thanks to the high operating leverage with E&P companies, plus the stock’s already-low valuation, even a moderate jump in crude oil could result in outsized gains for EGY.
Kohl’s (KSS)
Kohl’s (NYSE:KSS) is admittedly one of the cheap high-yield stocks that seems more like a “value trap” than a bona fide deep value play. Shares in the retailer are down by more than 15% over the past twelve months.
Worse yet, as InvestorPlace’s Marc Guberti argued last month, the company (which reported negative earnings last year) did not raise its dividend for 2023. This, coupled with the looming risk that economic challenges intensify before they improve, suggests that a reduction of KSS’s 7.78% dividend is likely.
Then again, maybe not. In mid-June, TD Cowen analyst Oliver Chen upgraded KSS stock, citing increased confidence in CEO Tom Kingsbury’s turnaround efforts. The company is also expected to swing back to profitability this fiscal year (ending January 2024), and shares (despite beginning to bounce back in recent weeks) trade at a low multiple (10.7) of these forward earnings.
Altria Group (MO)
Altria Group (NYSE:MO) has long been one of the undervalued high-yield stocks. The company, through its subsidiaries Philip Morris USA and UST, makes and sells cigarettes (Marlboro) and other tobacco products (like Skoal smokeless tobacco).
Yet there’s one area that Altria has failed to penetrate: the vaping market. So far, its efforts to “go smoke free” by diversifying into vaping products have resulted in big losses. This has made investors less bullish on MO stock due to concerns that earnings will start to decline, threatening MO’s high dividend payout (8.29%).
However, I wouldn’t underestimate the ability of this undervalued “sin stock” (trading for 9.2 times earnings) to keep delivering satisfactory returns. Although they are negatively affecting sales volumes, price increases continue to enable Altria to keep earnings steady. As a Seeking Alpha commentator recently argued, monetizing a “hidden asset” could MO remain a solid long-term stock.
Bank of Butterfield (NTB)
Bank of Butterfield (NYSE:NTB) is one of the best-value high-yield stocks among banks. This Bermuda-based bank is a leading financial institution in its home market and has a big presence in other major offshore financial centers.
Last March’s banking crisis knocked NTB stock lower, but the bank quickly assuaged investor concerns by pointing out its strong liquidity. Shares have bounced back since then, yet nonetheless remain very cheap, with NTB trading for only 6.5 times earnings. The stock also pays investors a 44-cent per share dividend each quarter. This gives NTB a forward dividend yield of 5.83%.
As seen in Butterfield’s most recently-released financials, this dividend is well-covered by earnings. Butterfield also has a return on tangible equity (or ROTCE) of 30.5%, well above that of even blue-chip banks like JP Morgan Chase (NYSE:JPM), which has an ROTCE of just 17.4%.
Sachem Capital (SACH)
The fact that Sachem Capital (NYSE:SACH) trades at a big discount to tangible book value is what makes it one of the undervalued high-yield stocks. At current prices, this mortgage real estate investment trust (or REIT) trades at a more than 30% discount to its tangible book value of $5.22 per share.
When I say SACH stock is a high-yielder, I’m not talking about a 5% yield or even a 10% yield. Sachem currently has a forward dividend yield of nearly 13.9%. Yes, given the current headwinds affecting real estate, there’s a good reason why Sachem is so cheap.
However, with its focus on short-term “hard money” loans to real estate investors, this mortgage REIT is arguably less risky than REITs holding residential or office building mortgages. Once real estate gets out of its current rut, SACH stock could provide big gains alongside a big yield.
Sinclair (SBGI)
Formerly known as Sinclair Broadcast Group, Sinclair (NASDAQ:SBGI) is a diversified media company, although broadcast television still makes up the bulk of its business. Like other “old media” names, shares have been hammered over the past year.
Yet despite the poor performance of SBGI stock since July 2022, it may be one of the best high-yield stocks in July 2023. Even as streaming points to the end of linear television, Sinclair continues to generate sufficient earnings to support a high dividend payout. At current prices, Sinclair (which trades for 5.5 times earnings) has a forward dividend yield of 6.93%.
As for the upside, Sinclair not only changed its name recently; it completed a holding company reorganization. The company believes this will lead to greater transparency around the value of Sinclair’s broadcast and non-broadcast assets. This, in turn, could help send shares to higher prices.
On the date of publication, Thomas Niel held MO. He did not hold (either directly or indirectly) any positions in any of the other securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.