3 Picks For Income Stocks To Start 2023

As investors become older, their investing philosophy often evolves. They often seek higher-yielding income stocks to boost passive income streams for meeting monthly expenses and living off dividends. The bear market in 2022 was a good opportunity to buy income stocks at a discount. Many had dropped in price and valuation as investors exited for the sidelines. But the fundamentals for some stocks are still solid.

That said, the strong start to 2023 has brought valuations up a little. But there are still deals, and many stocks are undervalued based on historical metrics. We discuss three undervalued income stocks that are also dividend growth stocks. The stocks are Verizon Communications Inc. (VZ), Washington Trust Bancorp, Inc. (WASH), and International Business Machines Corporation (IBM).

Criteria for Selection

To pick the three stocks, we require specific criteria to be met. The bullets below outline what we desired.

• A minimum dividend yield of 4%.
• At least 10 years of dividend growth for Dividend Contender status.
• A payout ratio of less than 65%.
• Three different sectors.
• Undervaluation based on historical price-to-earnings [P/E] ratio.

3 Picks for Income Stocks to Start 2023

Verizon Communications

My first pick is Verizon in the Communications sector. Verizon Communications is a stock I have written about often in the send half of 2022. Poor operating results and low expectations caused the stock price to plummet, and simultaneously, the dividend yield has soared to a decade high. The bottom line was investors wanted to see better retail cellular subscriber growth.

The stock market’s uptick, combined with the positive comments about subscriber growth from the Chief Executive Officer, caused the stock price to pop off its lows. He said,

“…the firm added subscribers on a net basis in the fourth-quarter. He added the health of the consumer was still “good” and that store traffic had improved.”

Also, the CEO stated the business will cut capital spending to about $17 billion in 2023 and 2024, down from about $20 – $22 billion in 2021 and 2022. Spending was higher in the past two years because of the 5G rollout. The lower dollar amount will allow Verizon to deleverage.

In addition, the company is targeting cost savings of $2 to $3 billion in 2025, which should improve margins.

While the company implements its plan, investors are paid to wait with the ~6.25% dividend yield. This percentage is below the decade-high but well above the 5-year average. The dividend grows at a 2% rate each year, and Verizon has raised it for 19 years. The company should become a Dividend Aristocrat with time because the payout ratio is only about 49%, meaning future increases should allow it to reach 25 years.

Verizon is undervalued, trading at an earnings multiple of ~8.3X, below the 5-year range. The stock is a buy now.

Washington Trust Bancorp

My second pick is Washington Trust Bancorp in the Financial Sector. At a time when some banks are struggling to meet quarterly estimates, Washington Trust is performing well. The firm beat the third-quarter forecast. Moreover, the more than 200-year-old bank is expanding in its home territory of Rhode Island, having opened one new branch in 2022 and planning to open three more in 2023. It does not sound like much, but it represents about 15% growth for the small bank. The bank’s CEO stated,

“We announced our intention to add three new branch locations in Rhode Island in 2023. These branches which are all in various stages of gaining federal state and local approvals will position as well to better serve the full Rhode Island community and to continue our in-market deposit growth. Our latest branch additions in East Greenwich and Cumberland Rhode Island have demonstrated the appeal of our high touch service model in the marketplace.”

A high-interest rate environment is usually good for banks because they increase their net interest margin by lending at higher rates but only increasing the deposit rates by a small amount. But the rapid increase depressed demand for mortgages and loans.

But Washington Trust is conservatively run with good asset and loan quality. Past due loans are at 0.16%, non-performing assets at 0.19%, and nonaccrual loans at 0.25%, all lower than the past three quarters and less than the all U.S. bank average for assets and loans.

Washington Trust is yielding 4.6%, above its 5-year average. The yield was only higher during the pandemic bear market in 2020. The firm recently increased the quarterly dividend rate by 3.7% to $0.56 per share. The 50% payout ratio provides confidence about dividend safety and future increases.

This conservatively run bank is undervalued based on a P/E ratio of roughly 10.9X, below the 5-year range.

International Business Machines

My third pick is International Business Machines in the Technology sector. International Business Machines is a stock I have written positively about since mid-2019. In fact, I was optimistic when many others were negative. Overall, the investment thesis of improving performance under the new CEO combined with the Red Hat acquisition in 2019 has turned around the technology giant. While not yet a leader in the cloud, IBM has a major presence in hybrid cloud and AI. Its market dominance in mainframes, leadership in transaction processing, and vast consulting network and experience add to the positives.

On the negative side, the IBM balance sheet has too much debt, and the dividend growth rate is now minuscule as the company focuses on top line growth and deleveraging. Next, there was a many years-long decline in revenue until 2020 that investors have not forgotten. Still, the firm’s leverage ratio is down from its peak, and the dividend was not frozen or cut. In addition, the current CEO is focusing on organic growth supplemented with bolt-on acquisitions.

IBM’s dividend yield is roughly 4.5%, below its all-time high and the 5-year average. But it is higher than most other companies that are not a real estate investment trust [REIT] or a master limited partnership [MLP]. Moreover, the dividend safety is acceptable, with a payout ratio of about 74% on adjusted earnings depressed from one-time charges. Also, free cash flow is $10+ billion, giving the business flexibility for growth, deleveraging, and returning cash to shareholders.

IBM is probably fairly valued now, partly because the stock had a positive total return of 10.6% versus the S&P 500 Index’s (-18.1%) in 2022. But if the current CEO is successful, the P/E ratio may expand to match other tech companies. In the meantime, investors have an excellent dividend yield to generate a passive income stream.