Yields Up To 5.8%, Top 3 Dividend Stocks To Buy In February

The stock market has started 2024 on a strong footing, with the S&P 500 (SP500) climbing 4.8% in just the first 38 days of the year.

However, unlike 2023 where a group of seven major companies, the Magnificent 7, drove most of the gains, this year’s rally is much more concentrated.

Just four stocks are responsible for nearly 75% of the S&P 500’s total return so far, highlighting a shift towards a more narrow market performance:

• Amazon (AMZN), YTD return 12.24%, Blended P/E 56.4x.
• Meta (META), YTD return 32.67%, Blended P/E 30.5x.
• Microsoft (MSFT), YTD return 10.11%, Blended P/E 38.1x.
• Nvidia (NVDA), YTD return 41.55%, Blended P/E 56.4x.

These concentrated returns have significant implications for the composition of market-weighted indices such as (SPY), where the concentration of the top 5 stocks has reached a staggering 25.5%, with information technology alone comprising over 30% of the weighting.

While this increases risk for investors who are solely buying indices, it also has major implications for the valuation of the index, which is now trading at 23.4x its blended P/E.

With EPS growth for 2024 forecasted to be 9%, this represents a rich valuation and is no longer a bargain, especially considering that over the past decade, the average P/E ratio stood at 20x earnings with a similar growth profile.

That being said, allow me to present three high-quality stocks that have experienced pullbacks due to recent developments, offering excellent buying opportunities for a dividend growth portfolio.

1. Realty Income Corporation (O)

Realty Income, known for its consistent monthly dividend payments, attracts a large following, particularly among Seeking Alpha investors.

This reputation is well-deserved, with the company currently offering a hefty 5.77% dividend yield, or $0.257 per share per month.

What’s even more impressive is the history behind these payments: Realty Income has declared over 640 monthly dividends and increased its dividend for 104 consecutive quarters.

The company’s dividend doesn’t just offer a high yield, it also boasts steady growth. Since 1994, the dividend has grown at a healthy rate of 4.3% per year. This stability and growth are further bolstered by Realty Income’s focus on single-tenant properties with triple-net leases, ensuring tenants are responsible for most property expenses.

Realty Income takes diversification seriously, with no single tenant exceeding 5% of the portfolio and the top 10 clients accounting for only 27.1%. Major tenants:

• Walgreens (WBA) 3.8% of annualized contractual rent
• Dollar General (DG) 3.8%
• Dollar Tree (DLTR) 3.3%

…further demonstrates the variety within the portfolio. This approach mitigates risks associated with relying on a single tenant or industry.

Realty Income’s commitment to diversification translates to impressive occupancy rates. Over the past two decades, the company has maintained an average occupancy rate of 98.2%, significantly exceeding the industry average of 94.2%.

This consistency underscores the strength of the company’s portfolio and its ability to attract and retain tenants.

Realty Income’s stock has faced pressure since the Fed began raising interest rates. Investors fear the company will struggle to refinance debt at higher rates while property values may decline.

While the Fed’s late-2023 signal to cut rates in 2024 sparked initial optimism and a rally in REITs, the stock has since retreated from its January high of $60 to $53.40.

This pullback presents a good entry point for income investors. Despite interest rate concerns, Realty Income’s 2023 funds from operations or ‘FFO’ remained stable, and further drops are unlikely unless rates stay unexpectedly high.

The market anticipates rate cuts starting in May, which could positively impact the stock’s valuation.

While Realty Income’s FFO growth since 2015 might not be the fastest among REITs, averaging 5.15% annually, it has consistently maintained a valuation of 20x its P/FFO.

Today, the expectation is for the growth to continue at a similar rate:

• 2024: FFO of $4.25E, 3% YoY Growth.
• 2025: FFO of $4.41E, 4% YoY Growth.
• 2026: FFO of $4.66E, 6% YoY Growth.

Yet, the valuation today is a mere 12.9x its P/FFO, implying a significant discount to its fair value over a period with similar growth.

As the rates get cut, I expect Realty’s Income valuation to return closer to its historical mean, with the potential for 25.5% total annual returns until 2026.

2. UnitedHealth Group Incorporated (UNH)

UnitedHealth is a clear example of a dividend growth stock you want to own in a dividend growth portfolio, especially when the stock is trading at the right valuation.

The company has managed to grow its dividend since 2010 by more than 61x and today pays $1.88 per share.

The dividend yield, at 1.45%, may seem low to some investors, yet you should consider purchasing this company for its growth potential rather than its income.

UNH stands as the largest healthcare company in the world, earning revenue through:

• Premiums: This is the core revenue source, collected from individuals and employers for health insurance plans offered through their UnitedHealthcare division. They cater to different segments like Medicare, individual plans, employer-sponsored plans, etc.
• Fees: UNH earns fees for various services like administering health plans, managing pharmacy benefits, and providing data analytics to healthcare providers. This is primarily done through their Optum segment.
• Sales: They sell healthcare products like medical devices and home care equipment.
• Investments: UNH invests its cash reserves to generate additional income.

The business is well diversified:

• UnitedHealthcare: Focuses on health insurance plans across various segments like Medicare, employer-sponsored plans, individual plans etc.
• Optum: Provides a wider range of health services beyond insurance, including:
  • OptumRx: Handles pharmacy benefit management and mail-order pharmacy services.
  • OptumInsight: Offers data analytics and consulting services to healthcare providers.
  • OptumHealth: Delivers care through its own network of clinics and health IT solutions.

UNH has faced recent pressure, sliding from its 52-week peak of $554 to today’s $519 due to earnings released by Humana (HUM), another major insurer.

Humana anticipates pressure on its business, projecting the continuation of increased medical care utilization observed in H2 2024 and into 2025. Similarly, UnitedHealth and CVS Health (CVS) have signaled challenges ahead, citing heightened utilization rates and a larger-than-anticipated medical benefits ratio, sending chills through the industry.

UnitedHealth, with its diversified business model, appears resilient in my opinion, capable of mitigating the impact of heightened utilization rates in its health insurance division.

Consequently, the growth trajectory is not expected to be significantly affected, with EPS growth forecasted at 11% for 2024, albeit slower than the 13% growth witnessed in 2023.

However, the growth is expected to continue beyond 2024:

• 2025: EPS of $34.45E, 13% YoY growth.
• 2026: EPS of $35.60E, 13% YoY growth.

Since 2015 the stock has traded at 21x its earnings on average, with an annual EPS over the same duration of 16.8%.

Today it is trading at 20.5x its earnings.

As the growth is expected to be somewhat more muted in the years to come, in my view, today’s valuation is not cheap but fair.

After the pullback, I see UNH as a good bargain today, with the potential for 14.6% total annual returns until 2026, alongside double-digit dividend growth.

3. McDonald’s Corporation (MCD)

While McDonald’s may not seem like the most exciting business at first glance, its slow and steady growth has actually led to market outperformance with lower volatility as the beta stands at 0.73.

This seemingly ‘boring’ approach has its advantages. However, the key driver of restaurant growth – new locations – has plateaued recently.

Despite this, McDonald’s expects a reacceleration with plans to open over 2,000 new restaurants globally, leading to a net increase of 1,600 in 2024.

Additionally, the company’s focus on efficiency has resulted in near record-high operating margins, which are expected to continue improving in the mid-to-high 40% range next year, significantly higher than peers such as Yum Brands (YUM) and Domino’s Pizza (DPZ).

So, while it might not be flashy, McDonald’s fundamentals suggest continued success through its combination of consistent growth and operational excellence.

Despite reaching a 52-week high of $300, McDonald’s stock has pulled back to a more moderate $287 following its latest earnings report.

While global comparable sales grew 9% in 2023, this slowed to 4.3% in the US and 3.4% overall in Q4 – marking the slowest growth in 11 quarters. This slowdown can be attributed to a confluence of factors: economic slowdown, rising interest rates, potential recessions, and even boycotts in Muslim-majority countries due to perceived pro-Israeli stances.

However, these headwinds are likely temporary. Historically, customers tend to return to their favorite brands after geopolitical tensions subside. Therefore, this pullback in the stock price presents an opportunity to acquire a fundamentally strong business at a more attractive price point.

In other words, McDonald’s may not be the flashiest option, but its steady growth, operational efficiency, and potential for post-conflict rebound make it a compelling investment for dividend growth portfolios.

Today, the stock is trading close to 24x its earnings, which would imply a fair valuation since 2015, as the stock has traded at 25.3x its earnings with an average EPS growth of 10.4% annually.

The growth is expected to continue; however, analysts are forecasting a dip in 2024 EPS driven by conflicts in the Middle East and Ukraine.

• 2024: EPS of $12.44E, 4% YoY growth.
• 2025: EPS of $13.53E, 9% YoY growth.
• 2026: EPS of $14.84E, 10% YoY growth.

With the growth reaccelerating after 2024, in my view, a 25x P/E is justified, implying a potential for 12% total annual returns.

At the same time, the company is paying a healthy 2.32% dividend yield, or $1.67 per share, which has grown 204% since 2010 and is expected to continue growing at a high-single-digit rate.

Takeaway

As we enter a new bull run for the stock market, which will likely be dominated by the AI narrative over the mid-term — a trend I am a big fan of — we need to be mindful that opportunities are becoming scarce, with the valuation of some companies stretched in relation to their forward growth.

In this article, I present three companies that have experienced a recent pullback, either due to interest rates, earnings, or the general market dynamics.

All three companies are high-quality stocks with a rich history of rewarding shareholders handsomely and growing their dividends.

Today, I am a buyer of all these stocks at current prices, as I believe they are attractively priced and the investment thesis has not changed, but prices have become more favorable.