Almost every single time I turn on my computer and open up my browser, there’s some mainstream media story about how broke Americans are.
I see headlines like:
“Most Americans can’t afford a $1,000 emergency.”
“Americans don’t have enough for retirement.”
”More Americans than ever working in their 60s.”
This is disappointing but not shocking.
After all, Americans love to consume.
However, while politicians like to pretend that we have a jobs and income problem, I don’t believe we do.
We have a lack of saving and investing problem.
I mean, I’m a great example of this.
I made middle-class money in my mid-20s, yet I was broke.
So it wasn’t an income or a job problem. I had a job. I made money.
It was a lack of saving and investing problem.
I wasn’t saving and investing my money, thus I had none.
But I turned that around in my late 20s.
I started aggressively saving my money, investing my savings into high-quality dividend growth stocks like those featured on David Fish’s illustrious Dividend Champions, Contenders, and Challengers list.
And by doing so, I was able to buy my time and essentially become “retired” in my early 30s.
I quit my day job at 32. And the passive income my real-life dividend growth stock portfolio generates on my behalf covers a substantial chunk of my real-life core personal expenses.
Amazingly enough, it didn’t take long for all of this to happen.
However, I had to take action.
And that’s what today’s article is all about.
I’m going to discuss a high-quality dividend growth stock that looks to be undervalued right now.
This will be a stock that’s filtered from David Fish’s aforementioned list, which is a compilation of more than 800 US-listed stocks with at least five consecutive years of dividend increases.
And it’s dividend growth stocks that I focus on when it comes time to invest, as I believe dividend growth investing is the best way to approach long-term investing.
Not only do stocks that pay and grow dividends tend to provide a better long-term rate of return than the broader market, the growing dividend income is in and of itself an excellent source of (growing) passive income that can be used to pay one’s bills, bypassing the need to work well into your 60s and becoming a mainstream media headline in the process.
So this could be your opportunity to take action!
The reason why I’ll be discussing a dividend growth stock that appears to be undervalued is threefold.
An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and less risk.
This is all relative to what the same stock would otherwise offer an investor if it were fairly valued or overvalued.
As such, undervaluation is very appealing on a number of levels.
The higher yield is generally available on undervalued stocks because price and yield are inversely correlated; a lower price results in a higher yield, all else equal.
So the cheaper the stock, the higher the yield (all else equal).
That higher yield also positively impacts total return by virtue of yield being one of two components of total return.
Capital gain, the other component, is also positively impacted due to the upside that exists between the lower price paid and the higher intrinsic value of a stock.
If you pay $50 for a stock worth $70, you have $20 worth of upside that could very well capitalize as the market realizes the real worth of the stock.
In the meanwhile, you probably have that higher yield (read: more income) to chew on.
And this all tends to lower one’s risk, too, as there’s a margin of safety that exists when one pays much less than that which a stock is worth.
With all this in mind, an undervalued high-quality dividend growth stock can be an excellent long-term investment.
And it could be your way out of mainstream media headlines.
So let’s take a look…
Compass Minerals International, Inc. (CMP) is a producer of essential minerals, including deicing salt and sulfate of potash.
Companies that specialize in commodities tend not to be favorite investment ideas of mine, as pricing power and brand names are both practically not possible to cultivate when it comes to commodities. In addition, commodity players tend to have high fixed costs.
However, there are a few special companies out there that operate at a high level and are thus able to pay their shareholders growing dividends for years on end.
Compass Minerals is one such company.
This company owns unique assets that are practically impossible for competitors to duplicate.
Namely, they own and operate a rock salt mine in Goderich, Ontario, which is the world’s largest active salt mine. Its size is a competitive advantage for Compass, but the location – on Lake Huron – is also a huge advantage, as this gives Compass excellent access to snowy cities across the Great Lakes region.
This long-life and extremely valuable asset should allow Compass to remain very profitable for a very long time, which means its dividend is likely to continue growing for the foreseeable future.
Growing a dividend is something Compass has a lot of experience with: the company has increased its dividend for 14 consecutive years.
And the dividend growth rate over the last 10 years stands at 8.6%.
Not a massive dividend growth rate, but it’s well in excess of inflation.
Furthermore, that dividend growth rate is pretty impressive when we consider that the stock offers a very appealing yield of 4.27% right now.
That yield is roughly twice what the broader market offers.
In addition, that yield is almost 130 basis points higher than the stock’s own five-year average yield.
So we discussed how undervaluation can lead to a higher yield and a higher long-term total return. Well, here you see how that can play out.
The stock has a payout ratio of 60.1%, which indicates the dividend still has room to grow roughly in line with long-term earnings growth.
All in all, the dividend offers a lot to like.
You’ve got a rather high yield (up there with a lot of utilities and telecoms), more than a decade of strong dividend growth, and a payout ratio that indicates no immediate trouble for the dividend.
But in order to determine what kind of future dividend growth to expect, we’ll want to look at the underlying growth of the business. After all, long-term dividend growth should roughly mirror long-term earnings growth.
Looking at this underlying business growth will also help us later estimate the intrinsic value of the company’s stock.
So we’ll first go over what Compass Minerals has done over the last decade. And then we’ll compare that to a near-term forecast for profit growth.
Combined, this should give us a good idea as to what kind of overall growth Compass Minerals is generating.
Compass Minerals has grown its revenue from $857 million to $1.138 billion from fiscal years 2007 to 2016. That’s a compound annual growth rate of 3.20%.
Meanwhile, the company increased its earnings per share over this same period from $2.43 to $4.79, which is a CAGR of 7.83%.
Looking out over the next three fiscal years, S&P Capital IQ anticipates that Compass Minerals will be able to compound its EPS at an annual rate of 15%.
This is obviously a substantial disconnect from what Compass Minerals generated over the last decade, with S&P Capital IQ calling for higher margins and better fertilizer fundamentals moving forward. However, commodities are notorious for volatile pricing, and the most recent winter was weak for snow around the Great Lakes region.
In addition, the company’s recent acquisition of full ownership (they previously owned 35%) of Produquímica Indústria e Comércio S.A., one of Brazil’s leading manufacturers and distributors of specialty plant nutrients, is expected to be accretive moving forward.
The company’s balance sheet is okay, though I think there’s room for improvement.
Notably, Compass Minerals took on some debt in FY 2016 to help fund the aforementioned acquisition.
The company’s long-term debt/equity ratio is 1.67, while the interest coverage ratio is just under 7.
Profitability is fairly robust, with both net margin and return on equity well into the double digits.
Over the last five years, net margin has averaged 13.36% and return on equity has averaged 25.59%.
I think the business is fairly solid across the board.
Underlying growth over the last decade is strong, and that’s expected to actually accelerate over the next few years.
Fundamentally, the only area for improvement is really the balance sheet, although that’s somewhat of a snapshot issue. If we would have looked at things a year ago, it would have looked a lot better.
Of course, this business, like all others, has risk. There’s climate risk and commodity volatility just for starters.
However, the company appears to be operating at a high level, the yield is very appealing, and snow/ice isn’t going anywhere anytime soon.
But no business is worth paying too much for.
So what might this stock actually be worth?
The P/E ratio for the stock is sitting at 14.08 right now. That compares quite favorably to the stock’s five-year average P/E ratio of 20.1. While earnings can be volatile due to the nature of the business, every meaningful valuation metric (P/B, P/S, etc.) is sitting below its respective recent historical average. Moreover, the current yield of the stock, as noted earlier, is substantially higher than its five-year average.
So the stock does appear to be cheap right now. But how cheap? What’s a good estimate of its intrinsic value?
I valued shares using a dividend discount model analysis.
I factored in a 9% discount rate (due to the high yield) and a long-term dividend growth rate of 5.5%.
This dividend growth rate is obviously conservative compared to the company’s long-term dividend growth rate, underlying earnings growth, and expected growth moving forward.
However, due to the volatility of the business and the nature of commodity pricing, I’d rather err on the side of caution here.
The DDM analysis gives me a fair value of $86.81.
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.
So even with a pretty conservative modeling of the future dividend growth for Compass Minerals, the stock still looks very undervalued here, which is consistent with the other valuation metrics. However, my analysis is just one look at a stock, which is why I like to compare my perspective and analysis with that of what professional stock analysts have concluded.
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 CMP as a 4-star stock, with a fair value estimate of $88.00.
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 CMP as a 3-star “HOLD”, with a fair value calculation of $65.00.
It’s interesting that the latter firm came up with a low FV, especially seeing as their 12-month target price on the stock is $82.00, which is right in line with the other valuations. Nonetheless, the averaged valuation (which factors in all three perspectives) is $79.94. That would indicate the stock is potentially 19% undervalued.
Bottom line: Compass Minerals International, Inc. (CMP) is a high-quality firm with well-placed and long-life assets that are incredibly valuable and nearly impossible to duplicate. The yield is competitive with a lot of utilities and telecoms offer, yet I think the possible 19% upside is greater than what you’d find in those other industries. This appears to be one of the more interesting and undervalued dividend growth stocks available at this time, and it’s absolutely worth a good look right now.
— Jason Fieber
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