Undervalued Dividend Growth Stock of the Week: Franklin Resources (BEN)

April 26, 2015
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Don’t you just love getting a good deal on something?

I know I sure do.

But getting a good deal on a high-quality dividend growth stock is absolutely the best, and far better than getting a good deal on a home repair, your groceries, or even a car.

And that’s because buying a great stock that pays and grows dividends for less than it’s worth will likely continue to reward you for years and years and years.

See, saving money on, say, a car is a one-time benefit.

If you buy a car that’s priced at $20,000 for $19,000, you saved $1,000. Awesome!

But keep in mind that the grand you saved on the car is a one-time savings.

It won’t compound for you.

Furthermore, that car will only likely depreciate over time, meaning the worth of the asset will decrease over time.

But buying a high-quality dividend growth stock for $40 when it’s really worth $50 could pay off for the rest of your life.

Not only do you get the likely boost in the value of your holding when the market realizes what a deal that stock is, moving its price up closer to its fair value, but a high-quality company will also very likely appreciate over time in market value as its profit increases.

Not only that, but since yield and price are inversely correlated, you’ll also receive a higher yield on your investment, which could compound for as long as you own the stock and as long as the company pays and grows its dividend.

That’s why I not only focus on the kind of high-quality dividend growth stocks that can be found on David Fish’s Dividend Champions, Contenders, and Challengers list, but I also try to make sure I’m paying less than fair value.

See price is what you pay, the price something is quoted at.

But value is what something is worth. And oftentimes, price and value are not at a 1:1 ratio.

If you need help determining a stock’s value, I’d recommend Dave Van Knapp’s valuation guide.

So you can see why I’m always interested in adding a great dividend growth stock that’s also currently undervalued to my personal portfolio. The benefits are too great to ignore.

And in search for one, I recently came across a stock that I’m going to share with you readers today.

Franklin Resources, Inc. (BEN) is an investment management company that offers asset management services to retail and institutional investors.

BEN has been around for a while, founded back in 1947. And they’ve done some amazing things over that stretch.

Together with its various subsidiaries, the company is referred to as Franklin Templeton Investments, which is a well-known name in the asset management space.

BEN has had some great tailwinds working in their favor lately, with a rising stock market over the last five years, continued pushing to retail clients to invest for their respective retirements, and continued expansion outside the US.

So let’s see how that’s worked out for them.

One of the most important aspects of a stock is its dividend growth record, and BEN doesn’t disappoint here.

They’ve increased their dividend for the past 35 consecutive years.

That’s incredible not just in absolute terms, but also considering that stretch of time includes multiple stock market corrections, the financial crisis, and the Great Recession.

And the rate at which they’re growing their dividend is equally incredible, with a 10-year dividend growth rate of 15.5%.

BENThat’s not too far out of line with what EPS has grown at over the last decade, which is why the payout ratio, at 16%, is still so low.

In addition, BEN routinely pays out special dividends which don’t show up in the usual stock screens. In 2014 alone, the special dividend approximately doubled the annual payout.

The only drawback here is the low yield of 1.15%. That’s not particularly appealing, and it’s also well below the broader market. Nonetheless, you’re getting a lot of quality and growth with that yield.

Let’s next find out how fast the company is growing, which will help us greatly with valuing the business.

The company has grown its revenue 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%. Not bad.

Meanwhile, earnings per share increased from $1.35 to $3.79 over this period, which is a CAGR of 12.15%. Impressive.

BEN has reduced its share count approximately 20% over the last decade, which has helped immensely with driving strong EPS growth.

S&P Capital IQ predicts that EPS will grow at a 5% compound annual rate over the next three years, which seems a bit conservative. However, any major pullback in global equity or bond markets would likely negatively affect BEN’s assets under management, which were $880 billion as of December 31, 2014.

One area of BEN’s fundamentals that is truly superb is their balance sheet. The long-term debt/equity ratio is 0.19 and they have an interest coverage ratio over 72.

BEN’s profitability isn’t the best in the business, but it’s very competitive and comparable. They posted net margin of 27.91% last fiscal year and return on equity of 21.89%. Obviously, these are great numbers.

There’s so much here to like. We clearly have a high-quality company that’s growing at a rapid clip, with excellent dividend growth history, a great balance sheet, and excellent profitability.

But is the stock a good deal right now?

BEN is trading hands for a P/E ratio of 13.88 right now. That compares favorably not only to the broader market, but also to BEN’s own five-year average P/E ratio of 15.4.

So the stock seems to be cheap. But how cheap? What’s it actually worth?

I valued shares using a two-stage dividend discount model analysis with a 10% discount rate and an initial dividend growth rate of 15% for the first ten years. I then used a terminal growth rate of 8%. The input seems reasonable to me, as recent dividend raises have been well in excess of 15%. The company has such a low payout ratio, that they could continue to grow the dividend faster than EPS for years to come. 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.

It seems to me that we potentially have a high-quality stock on sale here. But what do some professional analysts out there think of BEN and its valuation?

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 $58.20.

We certainly have a tight consensus here, with fair values ranging by only pennies. Averaging out the three numbers gives us a final fair value of $58.15. That would indicate that this stock is possibly 12% undervalued right now.

sc BENBottom line: Franklin Resources, Inc. (BEN) is about as high quality as it gets, with excellent profitability, strong growth, a fantastic balance sheet, and fantastic dividend metrics. The low yield is a bit of a drawback, but that occasional special dividend adds the potential for even more income here. The stock appears to have 12% upside right now, on top of the 1.15% yield. I’d strongly consider shares here.

– Jason Fieber, Dividend Mantra

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