While the stock market has started to recover from last year's swoon, there are still several bargains out there these days. That seems to be especially true among companies that pay dividends. Higher interest rates have made lower-risk income investments like bonds and bank CDs more attractive, which has weighed on the values of dividend-paying stocks.
Buying back its cheap stock
Pipeline giant Kinder Morgan expects to produce about $2.13 per share of distributable cash flow this year. With shares recently trading at less than $18 a piece, Kinder Morgan sells for 8.5 times free cash flow, or a 12% free cash flow yield. That's dirt cheap compared to the broader market. The S&P 500 trades at about a 5% free cash flow yield, while the Nasdaq Composite is even more expensive at around 4%.
That low valuation is the main driver of the company's high-yielding dividend. Kinder Morgan currently yields 6.3%, several times the 1.6% dividend yield of the S&P 500. The company can easily afford its big-time dividend. Kinder Morgan plans to pay $1.13 per share in dividends this year — 2% above last year's level — giving it a very reasonable dividend payout ratio of 53%. That enables Kinder Morgan to retain significant cash to fund expansion projects, repurchase its dirt cheap shares, and maintain its strong investment-grade balance sheet.
The company added $1 billion to its share repurchase program earlier this year, boosting the total authorization to $3 billion. It has spent $943 million of that to buy shares at an average price of $17.40. With its business producing plenty of excess cash, Kinder Morgan will likely continue using some excess cash to gobble up more of its incredibly cheap shares.
A bottom-of-the-barrel valuation
Diamondback Energy estimates it can produce more than $3.3 billion, or about $18 per share, of free cash flow this year if oil averages $80 a barrel (around the current level). With shares recently below $145 a piece, Diamondback Energy trades at about eight times free cash flow, or a 12.5% free cash flow yield.
The oil company plans to return 75% of that money to shareholders through its base dividend, share repurchases, and variable dividends. Diamondback's base dividend rate ($3.20 per share annually) gives it a current yield of around 2.2%. Meanwhile, its most recent total payment (base plus variable) of $2.95 per share in the fourth quarter gave it an annualized yield of 8.2%.
The company's flexible capital return program enables it to repurchase shares opportunistically. It repurchased 2.3 million shares for $316 million in the fourth quarter. It has used $1.58 billion of its $4 billion authorization. That leaves it plenty of capacity to continue buying back its cheap shares.
Taking advantage of the discount
Essex Property Trust trades at about 15 times its expected 2023 funds from operations (FFO). That's considerably below the more than 17 times FFO the average apartment REIT fetches these days. Essex's cheaper valuation is a big factor causing its dividend yield to be much higher than the peer-group average (4.4% vs. 3.3%).
Essex Property is taking advantage of the situation by repurchasing some of its cheap shares. The REIT made nearly $190 million of repurchases in 2022, the second most among apartment REITs. It bought back about 1.1% of its outstanding shares. The company repurchased shares at an estimated 12.2% discount to the net asset value of its apartment portfolio.
In addition to repurchasing shares, Essex Property Trust continues to increase its dividend. The REIT has 29 consecutive years of dividend increases, growing the payout by a cumulative 453% since its initial public offering in 1994.
Cheaper valuations drive higher yields
Kinder Morgan, Diamondback Energy, and Essex Property Trust all trade at dirt cheap prices. Because of that, they offer attractive dividend yields. It's also driving their decisions to buy back their shares. Those cash returns position these dividend stocks to potentially produce strong total returns in the coming years. That income with an upside makes them attractive buying opportunities these days.
Originally published on Fool.com
Matthew DiLallo has positions in Kinder Morgan. The Motley Fool has positions in and recommends Kinder Morgan. The Motley Fool has a disclosure policy.