Finding great businesses that are selling for less than they’re worth is challenging in today’s stock market.
The broader S&P 500 is, after all, up more than 92% over the last five years, before accounting for dividends.
When a large group of stocks move up in aggregate that much that fast, it’s tough to find stocks that are still offered for a good price.
[ad#Google Adsense 336×280-IA]What is a good price?
Well, a good price is that which is at or below what something is intrinsically worth.
You can pull up any stock quote and get a price.
And you’ll likely see that price change every second if you sit there and stare at and/or continually refresh the screen.
But does the value of a business really change that fast?
Not only unlikely, but nearly impossible.
So what we want to focus on is value, not price.
Value tells you what you should be paying. Focusing on value puts you in control and allows you to pick your opportunities.
And how you do that is you value a company – and its stock – independent of the market and pricing. Once you know what something is worth, you then have the chance to compare that to the current price and decide whether or not an opportunity is upon you.
To do just that, I’d strongly recommend learning how to value stocks. Toward that end, this valuation guide, put together by Dave Van Knapp, is extremely helpful.
Once you have the tools necessary to value stocks at your disposal, you’re in an excellent position to pay what you should, not just what the market is asking at any given time.
Buying stocks only when the price is in line with or below fair value is a hallmark of my strategy, which has in part allowed me to build a portfolio valued near $200,000.
But if you look at that portfolio, you’ll notice something else.
Almost every stock in the portfolio can also be found on David Fish’s Dividend Champions, Contenders, and Challengers list, which is a document containing the names of and information on more than 700 US-listed stocks that have all increased their dividends for at least the last five consecutive years.
There’s a reason for the correlation.
I almost exclusively buy stocks only if they’re regularly and routinely paying and increasing dividends to shareholders.
And that’s because, as a shareholder, it’s my right to collect a portion of the growing profits that these companies generate. I supply the capital as an investor, but I surely want to get paid for my time and risk.
Not only that, but we know that dividends account for most of the stock market’s long-term total returns, so why would I want to give that up?
So imagine the potential when you find a stock that’s listed on Mr. Fish’s list that’s also currently undervalued.
Well, that’s exactly what I recently found.
And I’m going to share that name with you readers today!
Viacom, Inc. (VIAB) is a global entertainment and media company, connecting with audiences in over 165 countries and territories.
Viacom might not be a household name, but its media and entertainment properties sure are.
They own cable networks like Nickelodeon, MTV, Comedy Central, and BET. Nickelodeon is one of the world’s leading cable channels for children, and is really the prime asset for the company.
In addition, the company owns more than 1,000 websites, which allows them additional platforms from which to connect to audiences and broadcast their content. As more content is consumed online, this provides them increasing and incremental benefits moving forward.
And then there’s Paramount Pictures, which is America’s oldest film studio. This accounts for approximately 1/3 of the business and has produced thousands of movies over its history.
What’s really interesting about this stock from an investor’s perspective is that Warren Buffet’s company, Berkshire Hathaway Inc. (BRK.B), has been a net buyer of this stock over the last few quarters, amassing a position worth over $500 million. Owning VIAB means you’d be in pretty good company.
Now, VIAB doesn’t have the type of incredibly lengthy dividend growth streak I typically look for. But that’s more than anything due to the fact they were spun off from CBS Corporation (CBS) in 2005.
But they have increased their dividend for the past six consecutive years, well on their way to a more impressive status in this regard.
And over the last three years, the dividend has been increased at an annual rate of 16.3%.
I typically like to see a dividend grow faster than inflation, meaning my purchasing power is steadily increasing.
VIAB obviously blows inflation out of the water with that kind of growth.
What you’ll often get with dividend growth that high is a really low yield – you typically can’t have it both ways. But VIAB actually offers a rather generous yield of 2.49%, which is well in excess of that of the broader market.
So you’re kind of getting your cake and you’re eating it too. You get yield and growth.
Notably, the five-year average yield for this stock is only 1.7%. So there could be an opportunity here to secure a much higher yield than normal.
This dividend growth looks set to continue as well. The company’s payout ratio – a measure of the amount of profit being returned to shareholders in the form of a dividend – is only 38.2%. So there’s plenty of room to continue increasing the dividend while still retaining a healthy portion of profit with which to grow the business.
But what about underlying growth of the business? Without that, dividend growth will eventually cease.
Let’s take a look at what kind of growth VIAB has posted over the last five years, which will help us with not only determining the safety and likely growth of the dividend, but also with valuing the company. I usually like to look at 10-year data, but VIAB was spun off in 2005.
From fiscal years 2009 to 2014, revenue increased from $13.619 billion to $13.783 billion. Negligible growth here, which isn’t what we want to see.
However, earnings per share is up from $2.65 to $5.43 over this period, which is a compound annual growth rate of 19.64%.
Major difference between the top line and bottom line. Improving margins and a substantial share buyback program – VIAB reduced its outstanding share count by more than 25% over the last five years – accounted for much of this.
That kind of growth is unlikely to be sustainable over the long run (there are only so many shares to buy back), but S&P Capital IQ anticipates that EPS will grow at an 11% compound annual rate over the next three years, which is still rather stellar.
One area of the company that does give me pause as an investor, though, is the balance sheet. The long-term debt/equity ratio is 3.40, which is quite high. And an interest coverage ratio below 9 isn’t great, either. VIAB isn’t in any financial danger here to be sure, but these numbers are rather poor for the industry. Worse yet, it’s been one steady deterioration of the numbers over the last five years.
Now, one aspect of the media and entertainment industry that’s really attractive is the potential for excellent profitability. It’s a really great business to be in if you’re looking to generate high margins and excellent returns on equity and capital (and who isn’t interested in that?).
VIAB doesn’t disappoint here, with some of the better numbers in the industry. Over the last five years, they’ve averaged net margin of 15.80% and return on equity of 32.32%. Great metrics here, though ROE has been bolstered recently by the increasing use of leverage.
There are a lot of positives here. Some of the best cable networks in the business, solid bottom-line growth, and great profitability. Plus, there’s obviously a commitment to returning value to shareholders through a growing dividend.
On the flip side of the coin you have a leveraged balance sheet and tepid revenue growth. In addition, people continue to consume content in ways other than through traditional cable connections, which could challenge the company’s competitive position in the future.
Berkshire clearly sees an investment case here and I’m inclined to agree. But is the stock a good buy here?
The stock’s P/E ratio is 15.33 right now. That’s well below that of the broader market, but curiously a bit higher than that of the stock’s five-year average of 14.1. Perhaps the market just doesn’t like this stock, because that’s a rather low average in this rising market, especially considering the growth and potential.
So we see the stock’s valuation is below that of the market, but what should we actually pay?
I valued shares using a dividend discount model analysis with a 10% discount rate and an 8% long-term dividend growth rate. That’s on the upper end of what I normally allow for, but I think it’s warranted considering the track record, quality, low payout ratio, and forecast for underlying profit growth moving forward. The DDM analysis gives me a fair value of $86.40.
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.81
My analysis indicates that there is a deal to be had here, but what do some experts think? Let’s compare my opinion to that of some professional stock firms that follow and value this stock.
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 VIAB as a 4-star stock, with a fair value estimate of $80.00.
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 VIAB as a 4-star “buy”, with a fair value calculation of $78.90.
If we average the three numbers out so as to work with one, final valuation, we get $81.76. That’s 27% higher than the stock’s current price, meaning we might have a significantly undervalued stock on our hands.
Bottom line: Viacom, Inc. (VIAB) owns numerous extremely profitable and high-quality media properties that span the globe. And those properties have provided for plenty of growth and plenty of dividend raises shareholders’ way. The company looks to be in a great position to continue that for years to come, and there appears to be an opportunity to buy into this Buffett stock with an above-average yield and the potential for 27% upside. I’d recommend taking a strong look at this stock.
— Jason Fieber, Dividend Mantra[ad#sa-income]