Just like it might take a little extra effort to find clothing on sale at your local department store – it’s never fun to go rooting around the clearance racks – it also is sometimes just a bit more strenuous to find high-quality stocks on sale.
But the reward is certainly well worth the effort.
Whereas it might feel great to score a nice dress shirt for 20% off, imagine what buying a high-quality stock for 20% below fair value will do your wealth?
While it’s unlikely a shirt will even be still in your closet in five years, a high-quality stock – especially one bought at a discount – can provide growing wealth and income for the rest of your life.
This is why I’m always looking for undervalued, high-quality dividend growth stocks to add to my six-figure portfolio.
And in order to discern between those stocks that are cheap and those that aren’t, you may want to check out this valuation guide put together by Dave Van Knapp.
See, buying a high-quality dividend growth stock is an excellent start.
But buying one on sale, where its asking price is below its intrinsic value, is even better.
That’s because not only will you benefit from the growth of the business, but you’ll also add in the potential for the immediate boost to wealth if the stock is repriced more in line with its value.
After all, sales don’t last forever.
In addition, your income will be higher – price and yield are inversely correlated – for the entire time you own that stock, which could be decades.
We may have ourselves a sale going on right now with one particular high-quality dividend growth stock.
Check it out!
Philip Morris International Inc. (PM) is the world’s largest publicly traded tobacco company, manufacturing and marketing a variety of tobacco products. Their products are sold in more than 180 countries, excluding the US.
This is a company that’s constantly underestimated yet continues to return tons of cash to shareholders.
A major portion of that return is in the form of a growing dividend, which just so happens to be my favorite source of return.
They’ve increased their dividend for the past seven consecutive years, which is as long as they possibly could have since the company was spun-off from Altria Group Inc. (MO) in 2008.
And the dividend growth itself is nothing short of spectacular – the five-year dividend growth rate is 12%.
That’s made even more impressive when you consider that the stock offers a yield of 5.14% right now. That’s significantly higher than most of what you’ll find out there right now.
The payout ratio is a bit high, currently at 83.7%.
However, like most tobacco companies, PM chooses to have a high payout ratio so as to return a significant portion of cash flow to shareholders directly in the form of a large dividend.
High yield and attractive dividend growth? How can you not love that?
Next, we’ll take a look at the growth of the underlying business.
We don’t have ten years of data for PM because of the aforementioned spin-off, so we’ll instead take a look at what kind of growth the company has managed to generate over the last five years. This will give us some insight as to where they’re potentially going, in addition to helping us value the company.
Revenue was $27.208 billion in fiscal year 2010. That improved to $29.767 billion in FY 2014. So that’s a compound annual growth rate of 2.27%.
Meanwhile, the company grew the bottom line at a slightly faster rate. EPS grew from $3.92 to $4.76 over that stretch, which is a CAGR of 4.97%.
Now, their results have been hampered by a strong dollar recently. But strong buybacks have helped the constrained net income go a lot further on a per-share basis.
S&P Capital IQ predicts that EPS will grow at a 9% compound annual rate over the next three years, although currency effects seem to indicate that’ll be difficult to achieve.
The company’s balance sheet shows negative shareholders’ equity due to large amount of treasury stock on the balance sheet from all the buybacks, but the interest coverage ratio, at over 10, indicates that interest expenses aren’t causing any issues for the company.
Profitability, as expected, is extremely robust. Their main product, cigarettes, are addictive and allow the company to maintain huge margins. Net margin for PM has averaged an incredible 27% over the last five years.
I’d say we have a high-quality company on our hands. However, high quality in this market tends to be expensive. Is that the case here?
The stock’s P/E ratio is currently just 16.29; well below the market and more or less in line with the stock’s own five-year average.
So what’s the stock worth? What should we pay?
I valued shares using a dividend discount model analysis with a 8% discount rate and a 4% long-term growth rate. That rate is lower than what underlying EPS has grown at over the last five years, so as to build in a margin of safety. With a high payout ratio, the dividend will likely grow at approximately the same rate as EPS moving forward.
Factoring in unique challenges to the company and industry is part of the reason behind the conservative growth rate. The DDM analysis gives me a fair value of $104.00.
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.
My perspective is that this is a high-yield, high-quality stock trading for a price below its intrinsic value, but what do others think about this stock right 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 PM as a 4-star stock, with a fair value estimate of $92.00.
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 PM as a 3-star “hold”, with a fair value calculation of $75.70.
Some differences of opinion there, but the average of the three numbers is $90.57, which indicates 16% undervaluation right now.
Bottom line: Philip Morris International Inc. (PM) offers one of the best combinations of high yield and attractive dividend growth in the entire stock market. And though their growth is constrained by a strong dollar, this is unlikely to persist forever. Meanwhile, the market has discounted the stock to a level that would appear to imply 16% upside in addition to that monster yield. I’d strongly consider this stock right now.
— Jason Fieber, Dividend Mantra