Loading up on passive-income opportunities at reasonable valuations can be a winning strategy for long-term investors.
This year has been a great one for the broader indexes like the S&P 500 and the Nasdaq Composite, which have been driven higher by outsize gains in megacap growth stocks. But other pockets of the market have done fairly poorly, like industry-leading dividend payers whose consistency and stability shine in a downturn but are getting overlooked in today’s market.
PepsiCo (PEP 1.10%), Deere (DE -0.76%), and Chevron (CVX -1.53%) stand out as three dividend stocks that have been underperforming the S&P 500 but look like excellent buys now. Here’s why.
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Put some pep in the step of your passive-income stream
In her 12-year stint as PepsiCo CEO, Indra Nooyi helped improve its brand and grow profits. Since taking over as CEO in October 2018, Ramon Laguarta has done a good job navigating many unexpected challenges, including the U.S.-China trade war, the worst of the pandemic, inflation, and supply chain bottlenecks. Effective management is extremely important, since every percentage point in margin can mean hundreds of millions of dollars.
For Pepsi, growth usually comes from new product developments, strategic acquisitions, or efficiency improvements. Nooyi was instrumental in helping Pepsi acquire Quaker Oats and Gatorade. But arguably the biggest deal under Laguarta’s tenure has been with the energy drink company Celsius (NASDAQ: CELH).
The company entered a partnership with the upstart beverage company in August 2022. It included a $550 million cash investment in exchange for convertible stock, an estimated 8.5% ownership in Celsius on a converted basis, and a 5% annual dividend. As with other consumer goods companies, Celsius shares have pulled back recently, but there’s plenty of reason to think the deal will pay off over the long term.
Celsius also benefits from using PepsiCo’s strategic distribution network. It is a complicated business — arguably far more complicated than its peer, Coca-Cola — because PepsiCo operates its own production facilities compared to Coke’s royalty/franchise model. PepsiCo is also involved in far more product categories besides beverages, like snacks and breakfast items, whereas Coke focuses on what it does best: beverages.
Pepsi has a lower market capitalization than Coke but generates roughly double the revenue and half the operating margin. Due to its size and business model, it is a bit more vulnerable than Coke. However, the company’s past management and current leadership have a track record of effective capital allocation.
Hovering around a 52-week low with a 3.3% yield, over 50 years of consecutive dividend raises, and a 24.5 price-to-earnings (P/E) ratio, PepsiCo stands out as an excellent stock to buy and hold for years to come.
Deere may be cyclical, but the stock is a bargain
After an initial surge in early 2021, Deere stock has gone practically nowhere despite achieving record profits last year. Unfortunately, there have been glaring signs that Deere could enter a downturn.
It is a highly cyclical stock. When the company’s customers are in expansion mode (and financing is inexpensive), they might be inclined to make a big purchase of its industrial machinery like farming and forestry equipment.
But when the cycle turns, Deere’s sales can fall in a flash. The trick is to pay a reasonable multiple based on a company’s mid-cycle earnings. Its P/E will look low when it is coming off a strong year and will be high coming off a bad year. Understandably, its P/E looks dirt cheap at just 10.9 — but earnings are expected to decline over the medium term.
Consensus analyst estimates have Deere earning $22.79 per share in fiscal 2024 and $22 in fiscal 2025, compared to $33.17 in fiscal 2023.
It would be one thing if Deere’s stock surged in lockstep with its earnings growth, but it didn’t. In fact, earnings have nearly doubled over the last three years while the stock is up just 3%. Deere’s earnings could be cut in half, and it would still have a P/E of about 22. It is simply too good a company to be this cheap.
DE data by YCharts. TTM = trailing 12 months; EPS = earnings per share.
Another reason to get excited about Deere is its earnings trajectory and automation and artificial intelligence advancements. The company has been ramping up research and development spending, investing in autonomous tractors, and automating farm tasks, such as crop spacing and recommended fertilizer use that can save operators money. It is making sizable product improvements that might not impact its bottom line until the next uptick in the cycle.
The stock only yields 1.6%, but that’s mainly because it uses both dividends and buybacks to reward shareholders. Over the last five years, the dividend is up over 93% while its outstanding share count is down 12.5%. That’s roughly the same pace of buybacks that Apple has done in the last five years, which is impressive considering Apple is famous for buying back a boatload of its stock.
Add it all up, and Deere looks like an excellent value stock to buy now.
A relatively safe way to invest in the energy sector
Chevron is another stock that has gone practically nowhere over the last year or so. There are a few factors at play. The first is uncertainty regarding Chevron’s acquisition of Hess, whose crown jewel is its stake in the Stabroek drilling block off the shores of Guyana. The other partners in the Guyana joint venture — ExxonMobil and CNOOC, a Chinese national oil company — are looking to stymie the deal and keep Chevron out of Guyana.
The good news is that Chevron doesn’t need the deal to go through to be a great investment. It can continue ramping up spending in its existing plays, namely the Permian Basin. It can also continue buying back its stock, which remains a good value with a 14.4 P/E ratio.
It’s also important to know how the market can reward or overlook certain qualities at different times. Right now, sentiment is optimistic, and peers like ExxonMobil are rewarded for higher spending and bold acquisitions.
Many other companies have followed suit. Even ConocoPhillips, which is known for being a conservative capital allocator, announced it is acquiring Marathon Oil in a blockbuster $22.5 billion deal. With Chevron’s major deal in limbo, there’s just one more box left unchecked.
Chevron’s financial health and prudence could also be getting overlooked right now. When oil prices are falling, investors often gravitate toward safe, stodgy, dividend-paying names like Chevron. And for good reason. Its financial health helped it acquire multiple companies at compelling valuations during the COVID-induced downturn when other producers were struggling to stay afloat.
For the last three years or so, oil prices have been remarkably stable and strong, which might convince some investors to gravitate toward riskier, more-leveraged plays. It could work out, but long-term investors know the best way to compound gains is to buy quality companies and hold them as long as the investment thesis remains intact.
In sum, Chevron has the qualities of an excellent long-term holding. Its greatest strength is its financial health, which is particularly important given the volatile nature of commodities like oil and gas. With its 4.2% dividend yield, the company stands out as a compelling choice for generating passive income regardless of oil prices.