The Best Dividend Paying Stocks with Low Beta
Nauman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Beta is a measure of the volatility or risk of a security in comparison to the market as a whole. A beta of less than one means that the security is less volatile than the market. Typically, stocks with less volatility are non-cyclical. They move in the same direction as the market at large and are less susceptible to day-to-day fluctuations.
For this article I've researched dividend paying companies with low beta. As global economic uncertainty adds to market volatility, investors may want to add some low beta dividend paying stocks to their holdings to reduce their overall portfolio volatility. Also, to make sure that I find the best companies, all three stocks mentioned in this article comply with the following criteria:
- Market cap of more than $300 million and an average volume of at least 300,000.
- Beta of less than .8 for low volatility.
- Net cash per share and current ratio greater than one, meaning good liquidity and dividend sustainability.
- EPS growth for the next five years greater than 10%, meaning that future dividend increases are more likely.
- DCF valuation discount of at least 20%, meaning that earnings translate into cash flow.
- Dividend yield of at least 2%.
The company develops analog semiconductor devices with a focus on III-V based products. It has $4.68 per share in cash, almost no debt, and an expected EPS growth for next five years of 11.5%. Analysts expect $2.85 in EPS for the next fiscal year, and the current stock price is only 11.8 times that figure, compared to peer average of 23 times, suggesting that Avago Technologies is significantly undervalued when compared to its industry and competitors.
It has made a name for itself with uncommonly good margins. The very high gross margin could be explained by the company's focus on rapid launches of innovative products that capture premium prices.
With an EBITDA margin of 30% and an operating cash flow margin in the high 20s, it has an impressive cash flow generation, and when I look at the enterprise value implied by the current stock price, it is only 9.65 times trailing EBITDA. Backed by strong free cash flow, the company should be able to further increase its cash reserve by $2.20 per share next year. This will increase its total cash to almost $7 per share and make future increases in dividend more likely.
I don't have much difficulty generating a model that points to 10%-12% long-term revenue growth at Avago Technologies, though I suspect that shareholders will call that a criminally low forecast. But, I've never done myself any harm by going conservative on long-term tech company sales growth rate estimates.
All told, I expect Avago Technologies to grow its free cash flow at a 12%-14% rate for the long term, which will lead to a steep-looking compound free cash flow growth rate of more than 17%. Discounting that back, it suggests a fair value of about $43.
The company operates as a mall and web-based specialty retailer in the United States.
It has $1.39 per share in cash, no debt at all, and an expected EPS growth for next five years of 26%. Analysts expect $0.56 in EPS for the next fiscal year, and the current stock price is 19 times that figure, compared to peer average of 23 times.
With an EBITDA margin in the low double-digits and an operating cash flow margin of around 7%, it has an impressive cash flow generation, and when I look at the enterprise value implied by the current stock price, it is only 5.65 times trailing EBITDA, much lower than the rest of the industry. Backed by strong free cash flow, the company should be able to further increase its cash reserve by $0.60 per share next year.
I'm comfortable with a long-term revenue growth outlook of high single-digits on Hot Topic. But since the company has little to no interest expense, it should be able to reduce the gap between EBITDA and operating cash flow margin by at least 20% through better management of the working capital. I expect the company to grow its free cash flow at a 3%-4% rate for the long term. Discounting that back, it suggests a fair value of about $15.
Healthcare Services Group
The company provides housekeeping and maintenance services to hospitals, nursing and retirement facilities.
It has $1.32 per share in cash, no debt at all, and an expected EPS growth for next five years of 18.5%. Analysts expect $0.95 in EPS for the next fiscal year, and the current stock price is 25 times that figure, compared to its peer average of 33 times.
It has historically managed mid-to-high single-digits EBITDA margins. Longer term, though, I believe the company can boost that margin into the low double-digits. Impressively, it has similar margins on both EBITDA and operating cash flow. This should enable the company to further increase its cash reserve by $1.15 per share next year.
Its impressive long-term compound revenue growth rate in the mid-teens would speak to long-term free cash flow rate in the high 20s, if not even higher. Discounting that back, it suggests a fair value of about $30.
The bottom line
Most investors prefer companies that pay dividends. But to generate safe and stable income in a volatile market environment, low beta dividend stocks are the way to go. With stable cash reserves, decent growth forecasts, and low beta, these dividend stocks offer investors a valuable source of regular income as well as the potential for long-term capital appreciation.
Nauman Aly has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!