Buy High-Yielding Stocks At Attractive Valuations

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As we move through the final quarter of the year, the signs of a slowing economy and cooling prices are becoming more obvious.

September’s manufacturing PMI dropped by a rather sharp 1.9 percentage points to 50.9%, the lowest since May 2020, with contraction in new orders and employment, as well as in exports. Backlog is fast approaching contraction levels and customers’ inventories, while still low, are approaching optimum levels.

There was some notable deceleration in the rate of price increases. Therefore, the manufacturing sector seems to be adjusting to a new normal of softer demand.

While the non-manufacturing PMI stood at a much stronger 56.7, it was still a slight decline from August’s 56.9. The relative strength is because of the shift in spending from goods to services, although demand for services has already started to soften.

Job openings dropped by 1.1 million in August, with the declines coming mostly in healthcare and social assistance, other services, and retail trade.

So things are moving in the desired direction. But whether it is enough to get to the 2% inflation ballpark the Fed is targeting is anybody’s guess. The Fed has to get inflation in line, but the sharp rate hikes that have taken the interest rate from 0 to 3% (soon-to-be 4%) in a matter of months could land the economy in a recession next year.

The several-month lag between the Fed’s actions and the impact on the economy necessarily requires this to be a calculated risk. And the job is not any easier given the strength in energy markets with the announcement of the latest production cuts.

Therefore, high-yielding value stocks are the way to go. But finding such stocks is easier said than done because the ongoing uncertainties have beaten down most stocks, not just the ones that have good long-term potential. So you could just as easily fall into a value trap.

And just because a company is paying a dividend doesn’t make it attractive in and of itself, because falling prices would have the effect of increasing yields. That doesn’t necessarily mean that the company is paying dividends simply because management believes its shares are undervalued, or because it's a matter of long-term policy.

That’s why it’s a good idea to combine these criteria with others. For example, the Zacks Rank captures positive estimate revisions. So if you’re picking stocks that also have a Zacks Rank of #1 (Strong Buy) or #2 (Buy), you are essentially choosing those that have seen recent estimate increases. Therefore, analysts are positive about these names.

Another easy way to shortlist stocks is to ensure that they belong to attractive industries. We all know that there are certain industry-wide factors that positively influence individual players.

Take oil prices, for example. When these are on the rise, there will naturally be a positive impact on companies producing and selling oil. Zacks classifies stocks into 250+ industries. Our research has shown that historically, the stocks in the top 50% of these industries outperform the bottom 50% by a factor of 2 to 1. Therefore, choosing stocks that belong to top industries increases your odds of picking winners.

Barings BDC, Inc. (BBDC - Free Report)

Barings is an externally managed investment company primarily focused on senior secured loans, first lien debt, unitranche, second lien debt, subordinated debt, equity co-investments, and senior secured private debt investments in private middle-market companies that operate across a wide range of industries.

It specializes in mezzanine, leveraged buyouts, management buyouts, ESOPs, change of control transactions, acquisition financings, growth financing, and recapitalizations in lower middle market, mature, and later stage companies.

The Zacks Rank #1 stock belongs to the Financial - SBIC & Commercial industry (top 5% of Zacks-classified industries). Barings is expected to grow revenues 61.3% this year and 10.2% in the next. Both 2022 and 2023 earnings estimates are on an upward trajectory.

The company’s dividend currently yields 11.27%, which is attractive even in the rising rate environment. The dividend has grown 9.59% in the last five years. Barings also doesn’t carry an unreasonable amount of debt. Its debt cap ratio at the end of the last quarter was under 40%, and it has come down a lot in recent quarters. High debt levels can be a concern when interest rates continue to climb.

The stock trades at 8.22X P/E, which is below the median level of 12.28X in the last five years and the 16.20X of the S&P 500. Therefore, the valuation supports buying the shares.

BRT Apartments Corp. (BRT - Free Report)

BRT is a real estate investment trust that owns, operates, and develops multi-family properties. The Zacks Rank #1 stock belongs to the REIT and Equity Trust – Residential industry (top 5%). The analyst providing estimates expect revenue growth of 123.0% this year and 35.8% in the next. Earnings estimates for both years are also moving up.

BRT’s dividend currently yields 4.90% and its dividend has grown 5.25% in the last five years. The debt cap ratio is around 56%, rather high considering the rising rate environment and especially since it is up from around 46% in September 2021. The stock trades at 10.6X P/E, which is below the median level of 14.95X over the past five years, indicating that valuation is cheap.

The Bank of N.T. Butterfield & Son Ltd. (NTB - Free Report)

The Bank of N.T. provides a range of community, commercial, and private banking services to individuals and small to medium-sized businesses (SMBs). It operates through offices in the Cayman Islands, Guernsey, Jersey, the United Kingdom, The Bahamas, Switzerland, Singapore, Mauritius, and Canada. The Banks – Foreign industry to which it belongs is in the top 23% of Zacks-classified industries.

Analysts expect the Zacks Rank #1 stock to grow its revenue by 10.6% this year and 8.6% in the next. They also expect its earnings to grow double-digits. Estimate revisions on NTB are also showing a positive trend.

The Bank’s dividend currently yields 5.09% and the dividend has grown 15.75% in the last five years. While debt levels have increased since the pandemic first hit in March 2020, the debt-cap remains very low at just 17.7%. Its current P/E of 7.28X is well below the median level of 10.02X over the last five years, suggesting that the shares are quite undervalued.

Orient Overseas (International) Ltd. (OROVY - Free Report)

Orient Overseas is an investment holding company, providing a broad range of container transport and logistics services in Asia, Europe, Australia, and North America. The Transportation – Shipping industry, to which it belongs is in the top 31% of Zacks-classified industries.

Analysts expect the Zacks Rank #1 stock to grow its revenue 156.8% this year, followed by some moderation next year. Both 2022 and 2023 earnings estimates have been raised substantially.

Orient Overseas also pays a dividend that yields 38.56% has grown 315.2% in the last five years, as the company returns to shareholders the windfall it has received as a result of supply chain disruptions. Its debt cap is very low at around 15.5%.

The shares are trading at an abnormally low level of 1.58X P/E. Investors appear to be discounting the shares as the current level of growth is unlikely to continue once supply chains normalize. Still, the valuation appears too low.

Three-Month Price Performance

Zacks Investment Research

Image Source: Zacks Investment Research

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