Markets

The 5 Best Value Stocks In The S&P 500 -- With Yields Up To 11%

They're some of the hottest stocks on the market.

#-ad_banner-#Since the start of this year, more than 200 of them are beating the S&P 500.

I'm not talking about bank stocks, IPOs, tech stocks, private equity... or even anything speculative, for that matter.

In fact, in the past these stocks have been called the most boring stocks on the market. They were once thought of as investments exclusively for widows and orphans.

But overlook them now, and you'll probably miss out on some of the market's best yields and returns.

I'm talking about dividend-paying stocks. And their popularity is gaining in this era of volatility and low-interest rates.

It's not hard to see why investors love dividend stocks . One only needs to look at their performance record over the past four decades.

According to a 42-year study by Ned Davis Research, from 1972 through December 2013, U.S.-based dividend stocks in the S&P 500 returned 9.3% a year on average -- far exceeding the 2.3% annual return for S&P stocks that didn't pay dividends.

To put that in perspective, if you had invested $10,000 in S&P 500 dividend-payers back in 1972, your investment would have grown to a whopping $413,100 today.

As dividend stocks have attracted more and more money over the past few years, many have become bloated and overvalued.

But before you jump out and buy the first dividend stock you see, be warned.

Amy Calistri, one of our top income experts and chief strategist for StreetAuthority's The Daily Paycheck advisory -- spotted this trend over a year ago :

Since Amy's article last April, many of the same dividend payers in the S&P 500 she talked about have become even more expensive based on their price-to-earnings (P/E) ratios.

Here's where things stand. Right now, the S&P 500 carries a P/E of roughly 17 (around its long-term historical average). Of the 418 dividend-paying stocks in the S&P 500, 241 are trading with a P/E over 17. And 39 dividend payers in the S&P 500 carried a P/E over 30 -- treading deeply into expensive territory.

It's not hard to spot dividend stocks that are getting bloated. Just look at these popular dividend payers' current P/E ratios:

Now, that's not to say these stocks are unsafe, but I'd much rather look for the best values in the market for higher dividend yields and returns.

So with traditional dividend payers now trading at premium valuations, how can investors find quality dividend stocks that aren't overvalued in today's market?

To find out, I screened every stock in the S&P 500. To weed out the riskiest stocks, I excluded non-dividend payers, companies that weren't profitable in the past year and stocks that are down over the past year. Each of these stocks also had to carry a trailing 12-month dividend yield over 4%.

As a final measure, to make sure I found the absolute best bargain dividend payers on the market, I used my favorite valuation metric -- the ratio of enterprise value to cash flow from operations (EV/CFO) .

For those that aren't familiar, enterprise value tells investors how much it would cost to buy a company after figuring in all the debt and cash a company holds. This is actually the same valuation many companies use before they try to acquire another business. Cash flow from operations tells an investor how much cash a company's core business generates -- the higher the CFO, the healthier the business.

EV/CFO is a similar ratio to P/E (which compares a company's market value to what it earned), but I like it more because it shows a clearer picture of a company's value. It also works well when comparing companies across several industries because it strips out things like depreciating assets and tax implications that can vary from business to business.

As a final bonus, the ratio is easy to read. A stock with an EV/CFO ratio that is 10 or less represents a very good value. This essentially means that it would take less than 10 years for the company to pay for itself (that is, buy all its outstanding stock and pay off all its debts) if the acquiring company were to use the operating cash flow the purchased company generates each year.

So, with my stringent demands in place, here are the absolute best bargain dividend payers on the market...

The most surprising to me here was AT&T (NYSE: T ) -- one of the few established dividend payers with a valuation that hasn't become lofty. In fact, not only does the stock still pay a yield of 5%, it's one of the best bargain dividend payers in the S&P 500. While its stock returns have been mostly stagnant, the company remains profitable and should keep conservative income investors happy -- especially if they choose to pick up shares when they're trading such low valuations.

The other telecom, Windstream Holdings (Nasdaq: WIN ) , pays a whopping 250% of its earnings in the form of dividends lending its payments to be a little more risky than AT&T's, but the company has managed to keep its dividend intact without a cut since 2007. The 11% dividend yield seems like an attractive offer to go with its bargain valuation.

Casualty insurance company Progressive (NYSE: PGR ) usually pays an annual dividend of around $0.40 a share every January (for a dividend yield around 1.5% to 2% at recent prices). Fortunately for those who like higher yields, it often pays an "irregular" dividend payment. Investors who held the stock over the past year earned $1.49 a share in dividends, giving them a solid 6% yield (as shown in the table above) at recent share prices. Now could be a good opportunity to buy the stock for its bonus dividends and strong upside.

Risks to Consider: While there are no guarantees in investing, each of these dividend payers has a strong chance of outperforming the market over the next few months and possibly years.

Action to Take --> For those with a bit more risk tolerance, high-yield telecom Windstream is an outperformer this year and offers a dividend yield five times higher than what the typical stock on the S&P 500 pays.

Progressive's dividend payments fluctuate more, but for those who don't mind that volatility, the stock is trading at a 17% discount to the overall market -- not bad for an established insurance company that's been around for 77 years. Finally, for those looking for reliable and growing dividends, I'd steer toward long-time dividend payer AT&T or utility company Entergy (NYSE: ETR ) , which pays a healthy 4.6% yield, is up more than 18% so far this year and still trades at an outstanding value compared with the market ( as my colleague Adam Fischbaum noted recently ).

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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