# This Dividend Growth Stock is Potentially 13% Undervalued

LyondellBasell (LYB) is one of the largest plastics, chemicals, and refining companies in the world. Headquartered in the Netherlands, the company went public in 2010 and has paid an increasing dividend every year beginning in 2011. That makes LYB a Dividend Challenger with a dividend growth streak of 7 years.

Dividend Safety

LYB yields about 3.7% and increased its dividend by 5.9% earlier this year. Is the dividend safe? For a complete discussion of dividend safety and reliability, see Dividend Growth Investing Lesson 17: Dividend Safety.

I use two services to assess dividend safety. The first is Simply Safe Dividends. They use this scale to score dividend safety:

Here is how Simply Safe Dividends scores LYB:

Simply Safe Dividends’ score of 78 out of a possible 100 points for dividend safety suggests that LYB’s dividend is safe and unlikely to be cut. The grade falls into the 2nd-highest safety ranking.

The other service that I use, Safety Net Pro, does not score this company.

Now let’s see how the company’s stock stacks up in terms of fair price.

Valuation Steps

To value a stock, I employ 4 methods and then average them out. For a complete discussion of my process, please read Dividend Growth Investing Lesson 11: Valuation.

Step 1: FASTGraphs Default Valuation

In the the first step, we check the stock’s current price against FASTGraphs’ basic estimate of its fair value.

For its basic estimate, FASTGraphs compares the stock’s actual price-to-earnings (P/E) ratio to the historical average P/E ratio of the whole stock market, which is 15.

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

By this way of reckoning, LYB is very undervalued.

To calculate the degree of undervaluation, we divide the stock’s actual P/E ratio of 9.9 (shown at the upper right) by the ratio of 15 that was used to draw the orange line.

We get 9.9 / 15 = 0.66. Translating that to 66%, this step suggests that LYB is 34% undervalued.

We can use that ratio to calculate LYB’s fair price: Divide its current price by 0.66. That’s \$97 / 0.66 or about \$147. (I round fair-value estimates off to the nearest dollar so as not to create a false sense of precision.)

Step 2: FASTGraphs Normalized Valuation

In the second step, we compare the stock’s current P/E ratio to its own long-term average P/E ratio. By doing this, we judge fair value by recognizing how the market has historically valued LYB itself rather than by how the market has valued all stocks over many years.

This second method suggests that LYB is slightly overpriced. Its long-term P/E ratio is 9.4 (see the dark blue box in the right-hand panel). Its current P/E is 9.9.

So the degree of overvaluation 9.9 / 9.3 = 1.06, or 6% overvalued. I consider anything within +/- 10% of fair value to mean that the stock is fairly valued. Again, I want to avoid any impression of false precision.

Using the same equation as in the first step, we get a fair value price of about \$92.

Step 3: Morningstar Star Rating (CFRA Substituted)

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

Morningstar ignores P/E ratios. Instead, they use a discounted cash flow (DCF) model. They discount all of the stock’s projected future cash flows back to the present to arrive at a fair value estimate. (If you would like to learn more about how this works, check out this excellent explanation at moneychimp.)

Unfortunately, Morningstar does not rate LyondellBasell at the present time.

For a substitute, let’s take a look at CFRA, which is another well-known independent research firm. (They used to be known as S&P Capital IQ.) Their most recent report on LYB indicates that they believe that the stock is fairly valued.

CFRA calculates a fair price of \$92.

Step 4: Current Yield vs. Historical Yield

Finally, as a 4th valuation method, we compare the stock’s current yield to its historical yield. If a stock is yielding more than its historical average, that suggests that it is a better value than usual.

LYB’s current yield is 3.7%. According to Morningstar, its 5-year average yield is 3.2%. Thus LYB’s yield is 16% higher than its 5-year average.

Doing the math, this method suggests that LYB’s fair price is \$113.

Valuation Summary

My final valuation is a simple average of the 4 approaches just described.

The average of the 4 fair-price estimates is \$111 compared to LYB’s actual price of about \$97. That’s a 13% discount to fair value, making the stock undervalued according to the methods that I use.

Disclosure and Caution

I do not own LyondellBasell. The fact that the stock’s valuation is favorable does not mean that I would select it for my own portfolio. A fuller analysis would be required.

As always, this is not a recommendation to buy LYB. Perform your own due diligence. Check out the company’s dividend record, quality, financial position, business model, and prospects for the future. Also consider whether it fits (or does not fit) your long-term investing goals.

— Dave Van Knapp