You see notices like this whenever you roll into almost any kind of store – grocery store, appliance store, department store, car dealership.
They alert you to something that is on sale, or perceived to be on sale.
At the very least, some type of merchandise is priced less than it was before.
However, it’s up to you to determine whether or not that new price actually represents a good value.
Unfortunately, the stock market is not such a place where the discounts are so evident.
A stock could literally drop 10% overnight, and unless you explicitly and specifically follow that stock, you might not even know about it.
There will surely be no sign accompanied by balloons.
Fortunately, we don’t need the signs.
We just need to be able to determine intrinsic fair value of a stock.
Just like with any other merchandise, stocks have price tags attached. You can pull up a quote on any stock and know exactly how much that stock will cost as of that moment.
But how do you know what it’s worth?
Well, one just needs to develop and use a system that determines the value of a stock with reasonable accuracy. A system like the one you can find right here on the site, discussed by fellow contributor and well-known author Dave Van Knapp.
While it’s not possible to get the value of a stock down to the exact penny, it’s plausible to ascertain a reasonable estimate as to what a stock is worth. And getting in the ballpark is really all you need.
A system like the one linked to above helps immensely. In addition, it’s important to remember these are real businesses that we’re looking at and potentially investing in.
Real products. Real services. Real people. Real money.
As such, value can be somewhat fluid. It changes slightly from day to day, or meaningfully if major news from a company is released.
Nonetheless, getting in the ballpark at least lets you know if the price is rational.
That then puts you in control, allowing you to only buy a stock when the price is at or, even better, below fair value.
The reason why this is important is because it can make a huge difference on your long-term wealth and income while also affecting the risk you take on.
For instance, paying $50 for a stock worth only $40 just put $10 per share at risk. If the market realizes the folly of this particular stock and reprices it more in line with what it’s worth, you can say goodbye to that $10.
Not only that, but you’re accepting on less income than you otherwise could have had.
All else equal, price and yield are inversely correlated. Paying $50 for a stock worth only $40 means the yield you accept on your investment is likewise 25% lower than it should be.
Conversely, paying $30 for that $40 stock means you’re getting an immediate boost on your yield while also putting much less capital at risk.
Not only are you not putting that extra $10 per share at risk, but you’re putting yourself in a position to realize the potential repricing to the upside, which could be an immediate boost to your investment and long-term wealth.
This is why I’ve tried to focus on stocks priced at or below fair value while building out my real-life portfolio.
This portfolio is my gateway to freedom. It will one day generate enough passive dividend income for me to live off of, thereby rendering me financially independent. As such, it’s imperative for me to avoid undue risk and boost my yield whenever possible. The more dividend dollars I can generate today, the closer I am to financial independence.
I also focus almost solely on dividend growth stocks, stocks like those you’ll find on David Fish’s Dividend Champions, Contenders, and Challengers list.
Mr. Fish’s “CCC list”, as it’s known, is a list of more than 700 US-listed stocks, all of which have increased their dividends for at least the last five consecutive years.
I invest in dividend growth stocks because I’m not after just passive income. No. I’m after growing passive income.
See, inflation will surely mean a dollar today is worth less next year, and possibly much less 10 years from now. So I need to make sure my income grows in kind. I want my purchasing power to at least stay intact. Even better if it can grow.
The stocks I invest in tend to increase their dividends well above the rate of inflation, meaning my purchasing power also increases. If $1 is worth $0.98 next year, I want my $1 of income to turn into $1.07 to more than offset that change. And that’s what my income tends to do.
Summing it up, I want to buy high-quality dividend growth stocks. But I also want a deal.
Too much to ask for?
I don’t think so.
For instance, there is a high-quality dividend growth stock on Mr. Fish’s list that right now appears to be significantly undervalued.
Want to know the stock?
Ventas, Inc. (VTR) is a real estate investment trust that owns a portfolio of nearly 1,300 senior housing and healthcare properties in the United States, Canada, and the United Kingdom.
Healthcare REITs like Ventas are one of my favorite plays right now.
You’ve got huge long-term tailwinds in the form of simple demographics.
Our population here in the US is growing larger and older all at the same time, and this is phenomonen is also occurring in other developed countries, like those Ventas is exposed to.
The US Census Bureau predicts that more than 20% of US residents will be over the age of 65 by the year 2030, which would be an incredible change from the 13% of the population that residents over the age of 65 represented as of 2010.
And while we all hope to age gracefully and remain completely competent enough to take care of ourselves, the simple fact is that old age does oftentimes bring on health issues that can sometimes require outside care. A larger base of potential clients means that Ventas (and other healthcare REITs) should do well over the long term.
This demographic tailwind has been playing out for years now, which has in part contributed to the company’s ability to pay a massive and growing dividend.
The REIT has increased its dividend to shareholders for the past six consecutive years after keeping its dividend static through the financial crisis. It’s worth noting that they didn’t cut their dividend during that period.
While not the lengthiest dividend growth track record around, they make up for a lot of that with the rate at which they’ve increased their dividend. Over the last five years, the dividend has been increased at an annual rate of 7.7%.
That’s obviously well above the rate of inflation, and it’s in line with a lot of well-known businesses out there.
But what makes that dividend growth rate even more impressive is the fact that the stock yields a monstrous 5.42% right now.
Future dividend growth bodes well for the firm since the payout ratio sits at just 69.7%.
So you’re not getting just a really attractive yield right now but also a dividend that’s growing rather rapidly.
I don’t see how one isn’t really impressed with the dividend metrics. Moreover, the underlying fundamentals and growth are also impressive, which further boosts my confidence in Ventas’s ability to continue growing its dividend. These numbers also lend to the belief that this stock is undervalued right now.
Revenue for Ventas is up from $325 million to $3.067 billion from fiscal years 2005 to 2014.
That ten-fold increase in revenue is breathtaking; however, Ventas funds a lot of its growth via the issuance of shares, and so that should be taken into account when looking at revenue growth. Factoring that in, revenue grew at a compound annual growth rate of 13.21%, which is still really incredible.
REITs like Ventas don’t use earnings per share to determine profit because of massive depreciation and amortization charges that can negatively affect EPS even though their properties are typically appreciating over time. Instead, we look at funds from operations, which adds those charges back in.
FFO per share grew from $2.22 to $4.29 over this period, which is a CAGR of 7.59%.
That growth is right in line with dividend growth, which makes sense since REITs have to legally pay out at least 90% of net income to maintain their status.
S&P Capital IQ believes that Ventas will compound its FFO/share by 6% annually over the next three years, which isn’t far of from what the healthcare REIT has done over the last decade. This isn’t far off from recent results and guidance, and this also takes the recent spin-off of its skilled nursing facilities into account.
Ventas’s balance sheet also seems appropriate when compared to peers.
Total liabilities of $12.3 billion line up against $8.7 billion in total equity. Credit ratings are as follows: BBB+ from Standard & Poors, and Baa1 from Moody’s. Solid, investment-grade stuff here.
Long-term tailwinds, a solid portfolio diversified across stable economies as well as by property type, and a wonderful record for underlying FFO/share and dividend growth are all attractive aspects to this business as an investment.
But is the stock priced right here?
The P/FFO ratio stands at 12.8, which is more or less in line with peers. That ratio, by the way, is similar to the P/E ratio one would use for normal corporations, so we can see why that appears so cheap at the outset. Moreover, the current yield is about 140 basis points higher than the five-year average.
It does seem quite cheap then. But what is a good price to pay? What’s the intrinsic value?
I valued shares using a dividend discount model analysis with an 8% discount rate and a 4% long-term dividend growth rate. That appears to be a conservative estimate when looking at the payout ratio, historical dividend and FFO/share growth, and forecast for FFO/share growth moving forward. The DDM analysis gives me a fair value of $75.92.
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.
This stock, from my perspective, appears to be significantly undervalued. But don’t take just my word for it…
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 VTR as a 4-star stock, with a fair value estimate of $81.00.
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 VTR as a 4-star “buy”, with a 12-month target price of $60.00.
I like to blend all three numbers together to give some consensus to the figures, and that averaged fair value is $72.30. I think that’s definitely in the ballpark here for this stock. That valuation would imply that the stock is 35% undervalued right now.
Bottom line: Ventas, Inc. (VTR) is a high-quality healthcare REIT with exposure to an industry that is almost sure to see long-term tailwinds from changing demographics. Their track record over the last decade is outstanding, and the stock currently offers a very attractive yield with dividend growth well above the rate of inflation. On top of all that, there might just be 35% upside here. I strongly advise long-term investors take a good look at this stock right now.
— Jason Fieber, Dividend Mantra
10%-Plus Yields from Stocks Like Microsoft, General Mills, Pepsi, Etc. [sponsor]
Not only have I been personally making these "10% Trades" with my own money, but I've been encouraging my close friends and family to do the same with theirs. I'll be pulling the trigger on my next "10% Trade" in the coming days. Details here.