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Finding value among U.S. dividend stocks

Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

Canadians love dividend stocks and it's not hard to see why. After all, they provide a nice stream of income that has a tendency to grow over time. In addition, Canadian dividends are taxed less onerously than regular income for many investors.

Problem is, some people become overly focused on Canadian names when hunting for good stocks. That's a shame because the Canadian market is heavily concentrated in mining, energy and financial stocks. For instance, there are relatively few Canadian technology stocks to choose from and the pending sale of BlackBerry may compound matters even more.

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To obtain a well-rounded portfolio, dividend investors should pick up at least a few international stocks. That's why I'm on the hunt today for U.S. dividend payers that might also appeal to value investors.

When it comes to dividend stocks, I like companies with good dividend growth records because they tend to be healthier than firms that pay steady or – even worse – declining dividends. While dividend growth isn't a perfect measure of business quality, it's not bad indicator in most cases.

Dividend growth is one thing, but I'm a value investor at heart. That means I like to buy lots of assets, or earnings, at a low price.

One good way to find bargains is to use a variant of the popular price-to-earnings ratio (P/E). Instead of price it uses enterprise value (EV) and instead of earnings it uses earnings before interest and taxes (EBIT). Just like P/E ratios, stocks with low EV/EBIT ratios tend to be loved by value investors.

You might not be familiar with enterprise value, but it is the market value of a business, including both equity and debt, that also adjusts for cash. You can think of it as an estimate of what a private buyer might have to pay for a firm while settling its debts at the same time.

Money managers Wesley Gray and Tobias Carlisle studied the effectiveness of using different value ratios in their book Quantitative Value and they gave the EV/EBIT ratio top marks.

For instance, they found that the 10 per cent of U.S. stocks with the smallest EV/EBIT ratios gained an average of 14.6 per cent annually from 1964 to 2011, whereas the S&P 500 only advanced 9.5 per cent over the same period.

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Based on that record I started my search with low EV/EBIT stocks and then stuck with firms that have grown their dividends recently. A few U.S. stocks that fit the bill, according to S&P/Capital IQ, are: Corning (GLW), DeVry (DV), Foot Locker (FL), Hewlett-Packard (HPQ), HollyFrontier (HFC), and The Gap (GPS).

I'm compelled to highlight Hewlett-Packard because it hasn't fared well in recent years, it was just dumped from the Dow Jones Industrial Average, and I hold a few of its shares.

The technology giant is based in Palo Alto, Calif., and last quarter roughly 50 per cent of its sales were generated by its PC and printing division, 46 per cent by its enterprise division, and the remainder from software and financial services.

HP passes the value test with an EV/EBIT ratio of six and dividend investors will like its 2.8-per-cent yield. Mind you, its dividend only really started growing – after a long hiatus – over the last few years.

The firm paid a quarterly rate of 8 cents (U.S.) a share in 2011, which is now up to 14.52 cents per share.

On the downside, HP has an unfortunate history of buying other companies at high prices that turn out to be worth less than anticipated. However, Margaret Whitman, its new chief executive, will hopefully prove to be a better capital allocator than her predecessors.

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On the whole, HP is more of a value stock than an income stock, but more aggressive investors should check it out.

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About the Author

Norman Rothery, Ph.D., CFA, is the founder of StingyInvestor.com and has been catering to value investors since 1995. He publishes the Rothery Report, a value stock newsletter. Norm obtained a Ph.D. in atomic physics from York University before following his passion for investing. More

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