4 Undervalued Dividend Stocks Starting To Rally

After moving up 10% since the end of January, this dividend stock sub-sector and the four stocks recommended today are perfect options to buy in this market. And, with possible double-digit dividend increases on the way in February, you can buy now before the stocks rise even higher.

The value of most shares in REITs have been beaten down by a series of investor fears including rising interest rates, a possible economic recession, and the general fear of holding stocks when the markets are volatile and declining. Now, while the rest of the REIT sector seems to still be looking for a bottom, the lodging/hotel subsector appears to have started to recover. With year-end earnings coming out soon, these stocks have the potential to produce both quick capital gains and long-term dividend income growth.

The hotel business is a very cyclical industry. Both room and occupancy rates drop significantly when the economy goes into recession. The hotel industry also has the habit of shooting itself in the foot by building out lots of inventory that typically comes online just before the economy starts into a downturn. The result is many empty rooms and hotels slashing room rates. Profits fall or go negative until the economy moves back into recovery mode, and then hotel profits can rise at a dramatic rate.

The current economic expansion has been somewhat different for the hotel industry. The slow-growth expansion coupled with the financial crisis hangover has dissuaded the industry from building new hotels. Instead, the trend has been to refurbish and rebrand existing hotels to generate higher room rates. With the economy continuing to grow at its moderate 2% per year pace, occupancy rates have also moved steadily higher.

Over the last couple of years, the better-managed hotel REITs have generated annual 30% to 50% funds from operations (FFO) growth and have announced similar increases in dividend rates. 2015 was the best year in recent history for dividend increases from the lodging/hotel REITs.

However, in January 2015, the market started to believe that the lodging cycle had peaked and was ready to turn downwards. Since late January of last year, the Dow Jones U.S. Hotel & Lodging REITs Index has declined in almost a straight line and is now 35% below its year-ago peak. Even as share prices were dropping, the better hotel REITs continued to put up quarterly revenue and FFO growth numbers.

Recently, market sentiment has turned concerning the hotel sector. The Hotel & Lodging REIT Index has gained a strong 10% since January 20th, 2016. It looks like the market is now expecting better results from the hotel REIT 2015 year-end earnings reports, which will be published over the next few weeks.

From the earnings reports, I am looking for 10% to 15% year-over-year FFO growth and similar sized dividend increases from those REITs that historically boost dividends at this time of year. Here are four of the better managed, more growth-focused lodging REITs that should give nice upside surprises when they release their financial results.

Pebblebrook Hotel Trust (NYSE: PEB) will announce earnings on February 22nd. Last year, Pebblebrook increased its dividend by 34%. In its third quarter earnings release, the company provided full-year FFO per share growth guidance of 27% to 33%. The current dividend is less than 40% of the most recent FFO per share amount. Expect a 25% dividend boost at least. PEB currently yields 5%.

Last year, RLJ Lodging Trust (NYSE: RLJ) increased its dividend by 50% with its fourth quarter earnings release. The next earnings report will be on February 24th. For the first three quarters of 2015, RLJ’s FFO per share was up 6.5%. The current dividend is about 50% of the annual FFO per share run rate. I am looking for a 5% to 10% dividend increase. RLJ currently yields 7.1%.

Apple Hospitality REIT Inc (NYSE: APLE) is a new lodging REIT, which came to market with a May 2015 IPO. The company will announce year-end earnings on February 25th. For the 2015 third quarter, Apple Hospitality reported year-over-year FFO per share growth of 12%. APLE pays monthly dividends and currently yields 6.2%. The company may not be ready to increase the dividend rate, but an earnings report with growing revenue and cash flow could boost the share price.

Xenia Hotels & Resorts Inc (NYSE: XHR) came to market one year ago, with a February 2015 IPO. The company will report yearend earnings on February 23rd. Third quarter FFO per share was up 57% from a year earlier and FFO for the first nine months of 2015 was up 26%. The current dividend is just 35% of the Q3 FFO per share. I don’t know if Xenia will announce a dividend increase this quarter, but if not this one, then definitely with the first quarter earnings. XHR currently yields 6.5%.

There are two ways to play these hotel stocks. In the short-term, share prices should rise between now and the next ex-dividend date, producing attractive returns. These are also stocks with several years yet to run in their growth cycles. I do not see a recession in the next couple of years, and if the economy keeps growing, these REITs could give you mid-teens to over 20% annual total returns for the next few years.

Finding stable companies that regularly increase their dividends is the strategy that I use myself to produce superior results, no matter if the market moves up or down in the shorter term. The combination of a high yield and regular dividend growth is what has given me the most consistent gains out of any strategy that I have tried over my decades-long investing career.