Exploring Quality Dividend Stocks for Smart Investors

Dividend Stocks Offer Attractive Returns

Investing in dividend-paying stocks is an excellent strategy for those seeking immediate returns. Companies that consistently raise their dividends tend to perform better and with less volatility compared to the broader market indices. This trend points to the fact that regular dividend increases encourage management to focus on disciplined capital allocation and signal a strong belief in the company's future growth potential to investors.

In this article, we will examine two prominent dividend-paying stocks that, together priced at around $500, appear undervalued. Both companies either just started paying dividends or have a notable track record of increasing payouts consistently.

1. Alphabet

Alphabet (NASDAQ: GOOG, NASDAQ: GOOGL) finds itself facing challenges, with its stock down approximately 5% recently amid heightened scrutiny over regulations affecting its search and advertising models. Investors are also concerned that Alphabet may be lagging in the race for advancements in artificial intelligence (AI), especially against competitors like Microsoft, which has a significant foothold in this burgeoning sector.

Despite these concerns, Alphabet continues to thrive, generating record levels of revenue and profit. In just the first half of 2024, the company reported net sales of $165.3 billion, alongside a remarkable net income of $47.3 billion, equating to year-over-year increases of 14.5% and 41.5%, respectively.

As of its most recent financial disclosures, Alphabet boasts a robust balance sheet, holding $88.9 billion in net cash. This financial strength likely facilitated the company’s decision to initiate its first-ever dividend earlier this year. Currently, Alphabet offers a quarterly dividend of $0.20 per share, translating to an annual yield of 0.53%. Notably, their payout ratio stands at a mere 2.8%, indicating ample room for future dividend increases.

In addition to dividends, Alphabet returns value to its shareholders through share repurchase programs. For instance, the company spent $31.4 billion on buybacks in the first half of 2024, effectively reducing its outstanding share count by 1.2%. Over the past five years, the outstanding share count has decreased by an impressive 10.9%, underscoring Alphabet's commitment to returning capital to shareholders.

Management is acutely aware of the significance of AI and is making substantial investments in this area. CEO Sundar Pichai has emphasized that the risk of underinvesting in AI is significantly greater than the risk of overinvesting, reinforcing Alphabet's dedication to staying at the forefront of this transformative technology.

In the first half of 2024, the company allocated $25.2 billion in capital expenditures, a notable increase from the $13.2 billion spent during the same period in 2023. Even as some question whether Alphabet is keeping pace with its competitors in the AI landscape, it remains a dominant player in online advertising and search. Furthermore, with a price-to-earnings (P/E) ratio of approximately 22.3, Alphabet is trading below its historical average of 26.8, suggesting it could be undervalued in today’s market.

2. Caterpillar

Caterpillar, Inc. (NYSE: CAT), recognized as the world's largest manufacturer of construction equipment, has seen its stock return a modest 1.5% over the past six months. Nevertheless, it is renowned for its consistent dividend policy, paying a dividend quarterly since 1989 and increasing it annually for an impressive 31 consecutive years. Currently, Caterpillar offers a quarterly dividend of $1.41 per share, resulting in an annual yield of around 1.7%. With a payout ratio of 23.7%, the outlook for continued dividend growth remains optimistic.

Similar to Alphabet, Caterpillar has been actively reducing its share count, bringing it down by 2.9% in 2024 and by 12.3% over the past five years. Management has communicated a strategy to utilize most of its free cash flow, derived from machinery, energy, and transportation sectors, towards dividends and stock repurchases. The anticipated cash flow for 2024 is estimated between $7.5 billion to $10 billion, although certain investors remain cautious. In 2023, Caterpillar generated $10 billion in free cash flow from its machinery, energy, and transportation unit.

The stagnation in Caterpillar’s stock price can be attributed to sustained high-interest rates, which negatively impact global demand in construction sectors. However, the recent decrease in net sales by 4% to $16.7 billion, along with a 7% drop in backlog to $28.6 billion year-over-year, does raise concerns.

There is, however, optimism on the horizon, as interest rates are projected to ease, potentially revitalizing demand for construction projects. The company stands to benefit from significant public infrastructure spending, stemming from the $1.2 trillion Infrastructure Investment and Jobs Act enacted in 2021. Additionally, with a lack of new housing developments since the Great Recession, there's considerable demand for residential construction, placing Caterpillar in an advantageous position.

Much like Alphabet, Caterpillar's current stock trades at a comparably lower valuation relative to its historical norms, currently trading at 15.5 times earnings against a median of 16.9 times over the past five years. This offers a compelling rationale for investors looking at undervalued dividend stocks.

Should You Consider These Dividend Stocks?

Both Alphabet and Caterpillar are well-positioned to reward their shareholders with rising dividends in the future. Investing in stocks known for consistent dividend growth is crucial for outpacing market performance over time. Given their promising valuations, incorporating these companies into your portfolio may be a wise investment decision.

Frequently Asked Questions

What are dividend-paying stocks?

Dividend-paying stocks are shares of companies that return a portion of their earnings to shareholders in the form of cash payments, known as dividends.

Why should I invest in stocks like Alphabet and Caterpillar?

Alphabet and Caterpillar have strong financials, a history of dividend payments, and are currently trading at attractive valuations, making them potentially lucrative investments.

What is a payout ratio?

The payout ratio is the percentage of earnings a company pays out as dividends to shareholders. A lower ratio often indicates more room for future dividend growth.

How can I benefit from dividend stocks?

Investing in dividend stocks can provide a steady income stream and the potential for long-term capital appreciation, as these companies often reflect strong business fundamentals.

Is now a good time to invest in dividend stocks?

Current market conditions, particularly with stocks like Alphabet and Caterpillar trading below historical averages, suggest it may be an advantageous time to consider investing in dividend stocks.

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