2 dirt-cheap dividend stocks set to beat the FTSE 100

Finding good value shares with high yields may seem tough while the FTSE 100 is near an all-time high. However, a number of sectors and stocks could still be worth buying for the long run. Here are two examples of stocks with low ratings and upbeat income prospects.

A difficult environment

Reporting on Wednesday was homewares retailer Dunelm (LSE: DNLM). It has experienced a difficult period, with the interiors industry seeing demand come under severe pressure in recent months. This has led to a 2.2% decline in like-for-like (LFL) sales in the third quarter. However, this still outperformed the wider sector with the margin increasing in the most recent quarter.

Looking ahead, more difficulties seem to be on the horizon. Inflation continues to march higher and this could cause disposable incomes to fall in real terms. The effect of this on Dunelm’s top and bottom lines could be negative, with the company due to report a 10% earnings fall in the current year. This could cause investor sentiment to worsen in the short run, although the market seems to have priced in a challenging period for the business. Evidence of this can be seen in its price-to-earnings (P/E) ratio of just 13.5.

Looking further ahead, Dunelm is expected to record a 14% rise in its earnings next year. This puts its shares on a price-to-earnings growth (PEG) ratio of around 1, which indicates that they offer excellent value for money. Their dividend yield of 4.2% is covered 1.8 times by profit, which indicates that shareholder payouts could rise significantly in future years.

While the company’s shares may be volatile, they seem to offer a potent mix of income and value potential which could lead to outperformance versus the FTSE 100.

Margin of safety

While Dunelm’s shares are cheap, international education market supplier RM (LSE: RM) appears to offer a substantial margin of safety. Its shares currently trade on a P/E of only 10.3 and since the company is forecast to record earnings growth of 16% next year, this equates to a PEG ratio of only 0.6. Therefore, even if operating conditions worsen and the company’s earnings forecasts are downgraded, its share price performance may remain relatively robust.

In terms of its income potential, RM currently yields 3.5%. This is below the FTSE 100’s yield of around 3.7%, but the company has significant dividend growth potential. Its payout ratio currently stands at around 36%, which indicates that dividend growth could beat earnings growth without putting the company’s finances under strain. And with dividends having more than doubled during the last five years on a per share basis, RM has a solid track record of rewarding shareholders when profit moves higher.

Therefore, while the FTSE 100 could continue to rise in the coming months, RM has the potential to outperform the wider index. Its mix of income and value potential may mean it delivers strong share price performance in the long run.

The best dividend shares

Of course, finding the best income stocks is never easy. With that in mind, the analysts at The Motley Fool have written a free and without obligation guide called Five Shares You Can Retire On.

The five companies in question offer stunning dividend yields, have fantastic long term potential, and trade on very appealing valuations. As such, they could deliver excellent returns and provide your portfolio with a major boost in 2017 and beyond.

Click here to find out all about them – it's completely free and without obligation to do so.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.