Separating price and value is incredibly important in all things that one can possibly purchase, but it’s especially important when it comes to buying stocks.
While price is that which you’re quoted when pulling up a stock’s ticker on any financial site, the value is much more difficult to ascertain.
But it’s not impossible to reasonably estimate a company’s fair value.
And in that pursuit, I’d recommend reading Dave Van Knapp’s guide to valuing stocks.
Every single stock you see in my personal portfolio was valued before its purchase.
And I estimated each and every stock to be priced at or below its fair value at the time of purchase.
Relying only on price alone for buying decisions will almost surely get you in trouble and perhaps lead to significantly overpaying for stocks.
And while my portfolio is now nearing $200,000 in value, I’m actively adding to it every month.
When looking for new stocks to add, the first place I look is David Fish’s Dividend Champions, Contenders, and Challengers list, which is a fantastic resource that tracks more than 600 US-listed stocks that have increased their respective dividends for at least the last five consecutive years.
As a dividend growth investor, one of my primary criteria before investing in a company is that it must have a track record of not only reliably paying dividends, but also regularly increasing those dividend payouts.
While I’m always on the lookout for high-quality dividend growth stocks, I won’t just pay any price.
Like I mentioned, price and value are different from one another.
Price is what you pay, but value is what you receive in return.
And when looking at dividend growth stocks, the lower the price you can pay, the more amount of potential capital gain you can possibly receive over both the short term and long term. Furthermore, and more importantly, the yield you’ll receive when you buy a stock will be higher if the price is lower.
After all, what would you rather have – a 3% yield or a 3.5% yield?
In my constant pursuit of high-quality dividend growth stocks that are also attractively valued, I recently came upon a stock that fits both criteria.
And I’m going to share that name with you today.
Franklin Resources, Inc. (BEN) is an investment management company whose services include fund administration and sales, marketing, shareholder servicing, trustee, and custody and other fiduciary services.
Investment management companies like BEN typically perform well over long periods of time due to a number of prevailing and powerful tailwinds.
First, as populations grow older they’ll need their assets to last longer in retirement which requires even more professional help.
Second, pensions are disappearing, which increases the need to save and invest for oneself to generate income in retirement.
Third, middle classes around the world are growing, which increases monetary supply and the possible need to store and grow that new wealth.
In light of these long-term trends it might not be surprising that BEN has increased its dividend for the past 35 consecutive years, which includes multiple stock market crashes, war, and even the financial crisis.
And over the last decade alone, the company has grown its dividend by an annual rate of 15.5%, which is nothing less than impressive.
Unfortunately, the yield’s a bit low at only 1.13%. But there’s a caveat there: The company routinely issues special dividends that boost its overall annual yield markedly.
In addition, the payout ratio is only 16%, which is absurdly low.
That leaves a lot of room to grow the dividend rather aggressively, even absent significant growth from underlying operations.
Speaking of underlying operations, let’s take a look. Looking at their growth will tell us a lot about where the company’s been, where it might be going, and also what it might be worth.
Revenue has grown from $4.310 billion in fiscal year 2005 to $8.491 billion in FY 2014. That’s a compound annual growth rate of 7.83% over the last decade.
Meanwhile, earnings per share increased from $1.35 to $3.79 during this 10-year stretch, which is a CAGR of 12.15%. Mighty impressive.
S&P Capital IQ is forecasting 5% compound annual growth for EPS over the next three years, perhaps due to strong equity performance over the last five years which could negatively affect inflows if the market starts to weaken significantly.
BEN’s balance sheet is fantastic, with minimal debt. The long-term debt/equity ratio is just 0.19, with an interest coverage ratio over 72. The company is in excellent financial condition.
Profitability metrics are also outstanding, and compare well to peers. BEN’s net margin was 27.91% last year, with return on equity of 21.89%.
Franklin Resources has obviously operated at a high level for a long time here. However, a great company isn’t worth any price.
BEN trades hands for a P/E ratio of 14.19, which compares well to its five-year average of 15.4. It would appear at first glance that the stock might be cheap. Not only is the current P/E ratio low relative to its own five-year average and that of the broader market, but it’s also low in absolute terms.
It might be attractively valued, but let’s see if we can value the business and put a number on it.
I valued shares using a two-stage dividend discount model with a 10% discount rate and a growth rate of 15% over the first ten years, which is in line with the last 10 years’ growth. I then used a terminal rate of 8%. This seems fair given their historical track record and extremely low payout ratio. The DDM analysis gives me a fair value of $58.26.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide. The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today. I find it to be a fairly accurate way to value dividend growth stocks.
So it appears that BEN is undervalued right now, perhaps substantially so. But my opinion isn’t the only one out there; analysts that follow this stock also have an opinion on the valuation, which we’ll cover now.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system. 1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates BEN as a 4-star stock, with a fair value estimate of $58.00.
S&P Capital IQ is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line. They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
S&P Capital IQ rates BEN as a 4-star “buy”, with a fair value calculation of $62.40.
Looks like we have a consensus here regarding BEN’s valuation. Averaging out these three numbers gives us a final figure of $59.53, which would imply that this stock is potentially 12% undervalued right now.
Bottom line: Franklin Resources, Inc. (BEN) is a quality company that has operated at a very high level for a long time. Great growth, excellent profitability, a wonderful balance sheet, and a very impressive dividend track record all bode well for shareholders – both current and future. Furthermore, the stock appears to be undervalued right now by a good margin, which might be a rare opportunity to pick up a high-quality dividend growth stock for an attractive price in an otherwise expensive market. I’d strongly consider this stock here.
— Jason Fieber, Dividend Mantra