This Stock’s Dividend Looks Very Safe and Shares Appear Fairly Valued

Note from Daily Trade Alert: United Technologies (UTX) is one of the 29 stocks selected for Dave Van Knapp’s new dividend growth “ETF”. The “ETF” just launched and is now open to the public. Investors can own all 29 stocks at once for a trading fee of just $9.95. Click here to learn more.

United Technologies (UTX) provides technology products and services to builders and the aerospace industry.

Products and services for builders include Otis elevators, escalators, and moving walkways; climate products such as climate controls; electronic security products; and fire safety products.

The company’s Pratt & Whitney segment supplies aircraft engines for commercial, military, business jet, and the general aviation market.

Its Aerospace Systems segment provides a myriad of products and systems to the aerospace industry, including power generation; flight management; engine and environmental control; engine components; lighting and seating products; and aftermarket services.

United Technologies was founded in 1934.

It is headquartered in Farmington, Connecticut.

The company is included United Technologies in my Dividend Growth “ETF” that kicked off on January 1, 2017.

United Technologies is highly rated for dividend safety. Simply Safe Dividends gives the company a score of 92 for dividend safety, meaning that its dividend is considered to be very safe.

captureSimply Safe Dividends’ scores range from 0-100 along the following scale:

captureSafety Net Pro gives UTX a dividend safety grade of B, which means that the dividend has a low risk of being cut.

captureTheir scoring scale looks like this:

Let’s go through our valuation steps and see how UTX stacks up. For a complete discussion of how I value stocks, please consult Dividend Growth Investing Lesson 11: Valuation.

Step 1: FASTGraphs Default Valuation

In the the first step, we compare the stock’s current price to FASTGraphs’ basic estimate of its fair value. That basic estimate is derived from a comparison of the stock’s price-to-earnings (P/E) ratio to the historical average P/E ratio of the whole stock market, which is 15.

That basic fair value reference level is shown by the orange line on the following graph, while the black line is UTX’s actual price.

captureBy this methodology, UTX looks a bit overvalued. Its black price line is above the orange fair-value line.

How much is the overvaluation? We answer that by comparing the stock’s actual P/E ratio of 16.8 (shown at the upper right) to the ratio of 15 that was used to draw the orange line.

We get 16.8 / 15 = 1.12.

In other words, UTX is trading at a premium of 12% by this first method of valuation.

Its fair price is calculated by dividing its current price by the ratio 1.12.

That’s $111 / 1.12 or $99.

I round prices off to the nearest dollar to avoid creating a false sense of exactitude.

Valuation is a process of assessing, not of making exact measurements.

That’s why we use multiple approaches. Let’s move on to the next one.

Step 2: FASTGraphs Normalized Valuation

In the second step, we compare UTX’s current P/E ratio to its own long-term average P/E ratio. In other words, instead of judging fair valuation by how the market has valued all stocks over many years, we judge it by how the market historically has valued UTX itself.

captureUsing this method, UTX is fairly valued.

I use a 10-year look-back period to compute the stock’s historical P/E ratio. As shown in the dark blue box, that is 16.4, which is indicated on the graph by the dark blue line. That represents fair value based on UTX’s own historical treatment by the stock market.

As you can see, UTX’s actual price falls just above the blue fair-value reference line.

As before, we can compute a fair-value price by comparing UTX’s present P/E ratio to the historical average: 16.8 / 16.4 = 1.02. In other words, this suggests that UTX is trading 2% above its fair value.

I consider anything within plus or minus 10% of fair value to indicate fair valuation. UTX’s fair price under this scenario is $109.

Step 3: Morningstar Star Rating

The next step is to see what Morningstar has to say.

Morningstar takes a different approach to valuation. It is called the discounted cash flow (DCF) model. They discount all of the stock’s future cash flows back to the present to arrive at a fair value estimate.

When this technique is done right, many investors consider it to be the finest way to value a stock.

captureMorningstar gives United Technologies 4 stars on a 5-star scale. They believe that UTX is undervalued. They have computed a fair price of $122.

Step 4: Current Yield vs. Historical Yield

Finally, we compare the stock’s current yield to its historical yield. The higher the stock’s current yield is compared to its historical average, the better value it represents.

UTX’s current yield is 2.4%. According to Morningstar, its 5-year average yield is 2.3%. Thus under this method, UTX is 4% undervalued, but within the fair value range. Its fair price is calculaated as 2.4 / 2.3 x current price, which comes out to $116.

Averaging the 4 Valuation Steps

Using the 4 approaches just described, our valuation for United Technologies comes out like this.

captureThus by my reckoning, United Technologies is fairly valued at the current time. It trades practically on its fair value price.

For a sanity check, I looked at S&P Capital IQ’s analysis of UTX. They assign it a current fair value of $112, have a 1-year price target of $119, and rate it a 4-star “buy.”

As always, this is not a recommendation to buy United Technologies. Always perform your own due diligence. Check out the company’s quality, financial position, business model, and prospects for the future. Also consider whether it fits (or does not fit) into your portfolio in terms of diversification and your long-term investing goals.

— Dave Van Knapp

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