Investors seeking stocks that can outperform during the next 12 months as earnings growth slows should consider 10 blue chips selling at significant valuation discounts versus the S&P 500. They are part of a 50-stock basket assembled by Goldman Sachs whose median component sells at a 30% discount to the index and many of which have outperformed the market in 2019 even as it has soared to new all-time record highs.

"Despite this multiple expansion, the basket’s relative valuation vs. the S&P 500 ranks in just the 8th percentile since 2006," Goldman writes in the current edition of their U.S. Weekly Kickstart report. Among the 50 equities in Goldman's Dividend Growth basket are these 10 stocks: Morgan Stanley (MS), Texas Instruments Inc. (TXN), Wynn Resorts Ltd. (WYNN), Broadcom Inc. (AVGO), Best Buy Co. Inc. (BBY), Hewlett Packard Enterprise Co. (HPE), Citizens Financial Group Inc. (CFG), Delta Air Lines Inc. (DAL), NetApp Inc. (NTAP), and Darden Restaurants Inc. (DRI).

Key Takeaways

  • Stocks with high dividend yields are valued at a discount.
  • This discount is near a 40-year high.
  • Many of these stocks also offer above-average dividend growth.
  • Pessimism about dividend growth is excessive, per Goldman Sachs.
  • While still valued cheaply, many of these stocks are beating the market.

Significance for Investors

The median stock in Goldman's Dividend Growth basket also offers a 50% higher dividend yield (3.5% vs. 2.0%) and a 100% higher projected average annual dividend growth rate, or CAGR, through 2021 (10% vs. 5%) than the median S&P 500 stock. Additionally, while the median stock in the basket has a higher dividend payout ratio than the median stock in the index (41% vs. 30%), that is still "manageable," as Goldman puts it. Regarding valuation, the forward P/E ratio of the median stock in the basket is 12.4 times projected earnings over the next 12 months, compared to 17.6 times for the median S&P 500 stock.

Goldman has this to say supporting their bullishness about stocks with high and rapidly growing dividends: "Investors receive a 25 bp higher dividend yield to invest in S&P 500 than a 10-year U.S. Treasury note. We expect S&P 500 DPS [dividends per share] will grow by 7% in 2019, 6% in 2020, and 5% on average through 2023. The dividend swap market is pricing a comparatively modest 2.7% average annual growth through 2023. Dividend growth pessimism is also evident in the valuation of high dividend yield stocks, which are trading at an extreme discount to stocks with low dividend yields."

Indeed, Goldman finds that the valuation gap between the 20% of S&P 500 stocks with the highest dividend yields (4.1% for the median stock in this group) and the 20% with the lowest yield (0% is the median for these stocks) is close to its widest point ever over the past 40 years, despite narrowing recently. The median forward P/E ratios are 13x projected next 12 months' earnings for the quintile with the highest yield, versus 24x for the lowest quintile.

Through Oct. 31, 2019, the median stock in Goldman's basket was up by 13% year-to-date, while the median S&P 500 stock gained 23%. Among the stocks in the basket, 17 of them (34%) posted gains of 23% or more. The biggest gainers included Best Buy (up 40%) and Citizens Financial (up 24%).

Electronics retailer Best Buy yields 3.1%, has a projected dividend CAGR through 2021 of 12%, and a payout ratio of 36%, below the basket median. Banking firm Citizens Financial yields 4.6%, has a forecasted dividend CAGR of 15%, and a payout ratio of 36%.

Looking Ahead

"Other metrics, such as EV/Sales and Price/Book, also show high dividend yield stocks trade at an unusually large valuation discount relative to stocks with low dividend yields," Goldman observes. Assuming that the market, and average market-wide stock valuations, do not crash, this is yet another reason why the stocks in Goldman's basket look attractive right now. "Looking forward, a wide dispersion of S&P 500 P/E multiples would typically support further outperformance of Value strategies, such as stocks with high dividend yields," they write.