To The Moon

Summary

• Dividend stocks are great in general, but not all dividend stocks are good buys.
• I discuss two overrated blue chip dividend stocks.
• I discuss two underrated blue chip dividend stocks.

ogichobanov

I love investing in dividend stocks because they are companies that are truly showing me the money. A company that consistently pays out a dividend is one that shows that it works for its shareholders and gives them a tangible share of the profits on a regular basis. Additionally, companies that pay out regular dividends and maintain a commitment to that dividend are generally much more disciplined in allocating capital than those that do not. This is because if they know they are going to have to pay out a certain percentage—especially if it's a meaningful percentage—of their earnings each quarter, month, or year to shareholders, they are going to have to high-grade the allocation of the remaining capital they retain. Therefore, the returns on invested capital will generally be higher than they would otherwise have been.

Additionally, companies that pay out dividends to shareholders do not have to generate as much growth in order to continue to generate attractive total returns. This is because a larger component of the return is being returned as cash to shareholders, and therefore less growth is needed to combine with that cash distribution to generate a satisfactory total return.

Finally, companies that pay out meaningful dividends often have stronger price floors than those that do not. This is because the yield acts as a bit of an anchor for the market, as the market will often price the yields of dividend stocks against yields offered by bonds and other income instruments. As a result, if a stock price falls too much, pushing its yield too high, the market may swoop in and buy up shares of the stock, as a whole, an additional class of investors—namely income investors—will likely then view it as an attractive alternative relative to other sources of income. In contrast, stocks that do not pay dividends generate their entire returns based on current and expected future growth and can be much more volatile. If the market grows bearish on the company's long-term outlook and there is no yield to make it attractive to income investors, the stock can plunge much lower at times.

That being said, just because a stock pays a dividend does not make it a good investment. In fact, many times dividend stocks become overvalued. In this article, I am going to discuss two dividend stocks that, I think, are being significantly overrated by Mr. Market, as well as two dividend stocks that are being significantly undervalued by Mr. Market. On top of that, I will be discussing one blue-chip BDC (BIZD) that I think is overvalued and one that is undervalued, as well as one blue-chip mining stock (GDX) that is overvalued and one blue-chip mining stock that, I think, is undervalued.

Overrated Dividend Stock #1

The blue-chip BDC that, I think, is overvalued right now is Main Street Capital (MAIN). While it has a very impressive track record of delivering market-crushing total returns and sustaining and growing its dividend over time—while also paying out attractive special dividends on occasion—its exceptional internal management gives it a lower cost structure relative to many of its externally managed peers. It also offers an attractive 7% next 12-month dividend yield. However, I think the stock is being materially overvalued right now, as its price-to-book value currently sits at 1.65 times, meaning that it trades at a 65% premium to the value of its underlying assets.

This is a significant premium on an objective basis. It is also a very significant premium relative to its history, as its historical average price-to-book value is 1.49 times. During periods of market concern—such as the 2008-2009 crash and the 2020 COVID crash—the stock has dipped below 0.75 times on a price-to-NAV basis. This indicates that the stock, without its NAV declining at all, could drop by well over 50% purely due to the collapse of its price-to-NAV ratio. When you combine that with the fact that short-term interest rates are expected to fall meaningfully in the coming quarters and years due to the Fed pivoting from rate hikes to rate cuts in the near future, and the fact that MAIN is significantly exposed to floating interest rates due to its significant concentration of floating rate loans, the company is expected to see its earnings per share decline at a 4.6% CAGR through 2026. It is therefore unlikely to see much, if any, dividend growth over that period of time.

As a result, while the 7% dividend is attractive and likely quite sustainable for the foreseeable future, it is unlikely to deliver an attractive total return due to the shrinking growth and the high probability of multiple compression rather than valuation multiple expansion. As a result, I think that MAIN is overrated and overvalued. While it is a fine pick for investors who simply want diversification and a stable, sustainable, attractive yield backed by a company with strong management and an excellent long-term track record, for investors who are trying to buy stocks on a value basis in pursuit of outperforming on a total return basis, I would steer clear of MAIN right now.

Underrated Dividend Stock #1

Golub Capital BDC (GBDC) is also a blue-chip BDC with a defensively positioned balance sheet and investment portfolio. Its leverage ratio is right around one, only slightly above MAIN's leverage ratio of about 0.9 times. Meanwhile, its dividend yield is significantly higher at 11% relative to MAIN's 7% dividend yield.

On top of that, 93.2% of its portfolio is invested in debt, whereas only 82.4% of MAIN's is invested in debt. This gives GBDC a more defensively positioned investment portfolio, especially when considering that 89% of its portfolio is invested in first and second lien loans, whereas only 68% of MAIN's is invested in first and second lien loans.

GBDC also has a relatively low expense ratio compared to many of its peers, making it much more competitive with MAIN on that front. According to CEFData.com, its gross asset expense ratio is 3.71%, which is only slightly higher than MAIN's gross asset expense ratio of 3.62%. By way of comparison, another prominent blue-chip BDC—Ares Capital Corporation (ARCC)—has a gross asset expense ratio of a whopping 6.09%. Despite that, ARCC trades at a 6.94% premium to net asset value, MAIN trades at the aforementioned 65% premium to NAV, while GBDC trades at a 2% discount to its NAV on top of having a more defensively positioned investment portfolio than either ARCC or MAIN, making it a much more compelling bargain at the moment.

Like MAIN and ARCC, GBDC is also expected to see a decline in earnings per share in the coming years and is unlikely to see much, if any, dividend growth. However, it's much larger margin of safety and the stronger, more defensively positioned investment portfolio give it a significant leg up on a relative basis, especially with its 11% dividend yield. If it can simply tread water in its valuation multiple and its earnings per share—which I expect to happen, as I expect the multiple to expand some to offset the earnings per share declines—its 11% dividend yield should deliver very attractive double-digit annualized total returns moving forward.

Overrated Dividend Stock #2

In terms of blue-chip mining stocks, Agnico Eagle Mines Limited (AEM) is overrated in my view. It has a very strong balance sheet, a stellar portfolio of high-quality assets, a strong track record of performing well and delivering value for shareholders, as well as relatively low geopolitical risk given that its assets are focused in favorable mining jurisdictions. However, it trades at a whopping 65% premium to its analyst consensus NAV per share and stands at a premium to its historical average of 1.4 times over the past five years, indicating that it is meaningfully overvalued at the moment.

Underrated Dividend Stock #2

Meanwhile, Barrick Gold (GOLD) is also a blue-chip miner with a strong balance sheet and strong management. While it does operate in more risky jurisdictional regions and has a bit of a more checkered past, it appears to be on much stronger footing moving forward, especially with its attractive copper growth profile to supplement its strong gold production profile. On top of that, it trades at just one time its NAV, despite its five-year average being to trade at about 1.2 times its NAV. Therefore, it has a meaningful valuation multiple with upside potential.

As a result, I view GOLD as being undervalued on both a historical and relative basis to peers like AEM, which trade at meaningful premiums to their own histories and relative to other miners. While AEM does deserve to trade at a premium, as its history indicates, based on its lower-risk jurisdictions and its more consistent operating history, GOLD still has quality assets, a disciplined CEO who has not been spending capital chasing expensive acquisitions, and has a promising growth pipeline in its copper business. I therefore think that the valuation gap between these two gold miners should narrow over time, making GOLD an underrated blue-chip gold miner, whereas AEM is an overrated one.

Investor Takeaway

As you can see in this article, quality is certainly an important trait when investing, but a blind chase of quality to the complete ignoring of valuation is also a mistake that investors can make. There are still plenty of high-quality opportunities out there, such as GBDC, GOLD, and many others, that are good businesses with well-positioned assets and well-managed portfolios, along with strong balance sheets and dividends, that are being underappreciated by Mr. Market today and still offer attractive value for opportunistic, long-term-oriented investors.