The Most Undervalued Dividend Stock in the Market

Of the questions I get every week, the majority are from investors that want to know how I choose between growth and income for my portfolio. I obviously have a bias to dividend stocks. After two huge market crashes in less than two decades, I like to be able to bank that regular cash flow even in the worst of times.

But even I cannot deny the feeling I get from looking at my portfolio statement and seeing price returns for a stock in the triple digits. And since long-term capital gains are now taxed at a lower rate than income, those price returns are worth even more.

The most obvious solution, get both income and high returns by looking for undervalued plays with high yields.

Finding undervalued dividend plays in an overvalued market

In 2009, you could throw a dart at the Wall Street Journal and come up with a great portfolio of undervalued names. Stocks were trading at fire sale prices and the highest quality names never lowered their cash payouts.

It’s gotten harder with the dividend-paying sectors like consumer staples and utilities jumping as investors stampede to find higher yields. Most names are way over their five-year average on price-to-earnings and book values.

There are still a few gems left if you know where to look

Shares of foreign companies traded on the U.S. exchanges still look pretty good. Investors in international names got crushed in the 2008 crash and most are still gun shy. With a negative long-term outlook on the dollar and an un-fixable debt problem, now is a good time to diversify yourself with companies based in economically-strong countries.

With a record amount of cash on corporate balance sheets, mergers and acquisitions are increasing and driving higher profit margins as well. Many industries in other countries are not as developed as they are here in the states which means there is more growth potential for an American acquirer or even within the domestic environment.

Beyond country and industry analysis, the rest comes down to good old fashioned stock picking. It can be a drag, but you really need to get into the financial statements of your stocks to forecast out their sales and earnings and compare it with the market price.

Combining an undervalued stock in an industry and country with growth potential could give you that growth and dividend pick we all dream of.

The most undervalued overseas company is not overseas

Canada’s stock market is probably the first stop investors take for their international diversification. The market is highly correlated with U.S. stocks but still lowers risk in a portfolio when Canadian stocks are added. Government debt is well below that of the U.S. and the economy is forecast to grow by better than 3% next year.

Higher interest rates and stronger economic growth means that the Canadian dollar should continue its appreciation against the U.S. greenback. The “loonie,” has appreciated by about 3% annually over the last decade, pushing the value of Canadian assets up in USD terms.

Wireless penetration in in Canada is just 80% compared to 102% in the United States, meaning the industry still has some strong growth ahead before it reaches saturation. The industry in the United States has been going through a consolidation phase and companies are looking for international growth.

Rogers Communications (NYSE: RCI) is the largest of Canada’s three national wireless carriers and includes Rogers Wireless (65% of 2012 Revenue), Rogers Cable (30%) and Rogers Media (5%). The company has a lock on wireless with 40% of the market and more than half of the smartphone market. Rogers Cable is also the nation’s largest cable network with more than two million television subscribers and a million internet subscribers.

Management bought back almost 10 million shares last year for $350 million, helping to push the dividend yield to 3.7%. What is impressive is that the company was able to manage a strong investor cash return while still investing more than $2 billion in capital spending last year.

The shares trade for just 13.0 times trailing earnings, below the five-year average of 15.5 times and well below the industry average of 27.3 times earnings. Morningstar has a price-to-fair value ratio of 0.7 on the shares, meaning that the stock could be as much as 30% undervalued.

My own target for the shares, at $56 per share, is slightly below Morningstar’s $60 fair value but still a 26% upside to the recent closing price.

The company is closely held by family members of the founder Ted Rogers and investors do not have the same voting rights as with other companies. The company has a non-family member CEO and an independent board so I do not see a problem with the control issue. The family may get in the way of a possible sale but may also decide to sell if the price is right. Even without an eventual sale, consolidation among peers could help to improve margins industry-wide.