Undervalued Dividend Growth Stock of the Week: TJX Companies Inc. (TJX)

The rich keep getting richer.

If I had a penny for every time I’ve heard this phrase, I’d be, well… rich.

But why is this so? Why do the rich keep getting richer?

It’s because wealthy people, and those striving to become wealthy, invest their capital into high-quality assets that provide inflation-beating appreciation, oftentimes along with passive income that also grows at above-inflation rate.

When one does this, it’s an inevitability that they will become wealthier and more financially independent over time. 

So the rich do keep getting richer.

But the thing about this is, nothing is stopping you from becoming one of the rich!

I realized this a few years ago, back when I was most certainly nowhere near wealthy.

Sitting on more debt than assets, I made people who were broke look rich.

But I decided to turn my life around by doing three things: increasing my income, decreasing my expenses, and investing the difference into high-quality assets.

Sounds simple?

That’s because it is. It’s not a complex or new idea. The most timeless ideas are usually the best.

However, it’s difficult to execute this – day in and day out – in real-time, in everyday life.

But anyone can do it. And if you have the ability to see it through, amazing results can be yours.

I speak from experience, as I went from below broke to building the bulk of the six-figure portfolio I now own and control, in about six years’ time.

This portfolio – chock-full of high-quality assets that tend to appreciate faster than inflation, all while paying growing passive income along the way – generates the five-figure passive income I need to cover my basic expenses in life, rendering me financially independent in my 30s.

Those high-quality assets are dividend growth stocks like those you can find on David Fish’s Dividend Champions, Contenders, and Challengers list.

Mr. Fish has compiled data on more than 800 US-listed stocks that have paid their shareholders increasing dividends for at least the last five consecutive years.

When you think of the “rich”, two words probably come to mind: stocks and dividends.

There are good reasons for that.

Great businesses tend to vastly outgrow inflation over the long run.

And great businesses very often directly reward their shareholders with a portion of the growing profit great businesses generate, which is executed via growing dividend payments.

Warren Buffett himself is a great example of how this plays out, as the common stock portfolio he oversees for his company, Berkshire Hathaway Inc. (BRK.B), is largely invested in great businesses that pay growing dividends.

High-quality dividend growth stocks are the stocks I advocate, write about, and personally put my hard-earned capital to work with.

But that doesn’t mean one should go out and buy dividend growth stocks in some kind of random way.

One should first make sure they perform a full quantitative an qualitative analysis on any prospective business they might be interested in investing in, making sure business growth, profitability, the balance sheet, and all other fundamentals pass muster. In addition, durable competitive advantages should be in place.

But even a great business can be a poor investment, especially over the short term, if the price paid is far too high (relative to value).

Price is what you’re going to pay for something, while value is what you’re going to get for your money.

Price is essentially cost, while value is essentially worth.

Knowing the former is easy and of very little importance. Knowing the latter, however, is a bit more difficult but far more useful.

As for how useful it might be, buying a high-quality dividend growth stock when it’s undervalued (i.e., when its price is below its intrinsic value) can confer substantial benefits to the long-term investor.

An undervalued dividend growth stock can offer an investor a higher yield, greater long-term total return prospects, and less risk. 

This is relative to what the same stock might otherwise offer if it were fairly valued or overvalued.

The higher yield comes about because price and yield are inversely correlated; all else equal, a lower price will result in a higher yield.

That higher yield dynamic should result in not just more dividend income right off the bat, but it could very well positively impact one’s long-term, aggregate dividend income.

Since total return is comprised of income (via dividends or distributions) and capital gain, total return is given a boost right away based simply upon the higher yield one can capture when undervaluation (and thus a higher yield) is present.

But it gets better.

Greater long-term total return prospects are also likely given to the investor via the “upside” that exists when price is well below value, as the market could very well reprice a stock closer to its value when the value is realized by the market.

While the stock market isn’t necessarily very good at pricing stocks over the short term, price and value tend to more closely correlate over the long run.

And so significant undervaluation can act as a springboard for capital gain, thus improving one’s long-term total return prospects.

All of this serves to also reduce one’s risk, because a margin of safety should be available when price is well below intrinsic value.

A margin of safety acts as a “buffer” for the long-term investor, protecting one’s downside just in case something goes wrong with the business/investment.

If you pay fair price or more, you don’t have that buffer, meaning it is very easy to end up underwater (the investment’s value being below the price you paid).

With these benefits being so clear and powerful, one might expect it to be an extremely difficult task to find undervalued dividend growth stocks.

However, I don’t believe that to be so.

But one needs to first have a clear idea of how to value a stock.

The good news here is that fellow contributor Dave Van Knapp has come to the rescue, with his dividend growth investing lesson on valuation making the process of valuing dividend growth stocks pretty simple and straightforward.

We won’t leave you investors there, though.

I’m going to highlight a high-quality dividend growth stock that appears to be undervalued right now, which could provide long-term dividend growth investors a compelling investment idea…

TJX Companies Inc. (TJX) is an operator of off-price apparel and home fashions retail chain stores in the US and certain international markets.

As the largest off-price apparel and home fashion retailer in the United States, TJX Companies has achieved a level of scale and brand recognition that bolsters its unique position in the US retail space.

The company operates more than 3,800 stores in 9 countries (spread out across 7 retail chains) and 3 e-commerce sites. The bulk of its B&M retail offerings are in the ~1,200 T.J. Maxx stores, 1,000+ Marshalls stores, and 570+ HomeGoods stores it operates.

While the US is arguably “over-retailed”, the combination of saturation and a larger trend toward e-commerce shouldn’t affect TJX Companies as much as other traditional B&M retailers due to the “treasure hunt” experience the company offers across its stores.

Indeed, while many traditional B&M retailers have had measurable levels of success with e-commerce platforms of their own, TJX Companies generates an immaterial amount (~1%) of its annual sales from its e-commerce offerings.

This, in my view, should be looked at as a strength, rather than a weakness, as it proves out the business model – shoppers enjoy browsing the off-price apparel and home goods in person so as to seemingly maximize their experience and value.

In addition, while many retailers have had difficulty with comps, TJX Companies sports 21 straight years of comp store increases.

Perhaps just as impressive, the company also has delivered shareholders 21 consecutive years of dividend increases.

In the retail world, that’s practically a lifetime.

Moreover, these dividend increases have been massive.

The 10-year dividend growth rate stands at 22%.

And lest you think they’re slowing down, the most recent dividend increase was over 20%.

So no marked deceleration off of what’s a rather incredible base, which is notable.

With a payout ratio of just 33.8%, there’s still plenty of room for double-digit dividend increases for the foreseeable future.

In fact, due to strong business growth (which we’ll see in a moment), the payout ratio hasn’t increased all that much over the last decade. This is one of the few instances in which I’ve seen massive dividend growth over a long stretch of time actually look so sustainable and rational.

The only drawback I see to the dividend metrics is the yield.

At 1.62%, there’s certainly something to be desired in terms of current income.

As such, investors/retirees who are in need of a little more bird in the hand (instead of two in the bush) may find this stock slightly unappealing as a result, and I see this stock as better candidate for younger investors who have time for that dividend growth and compounding to work in their favor over the next few decades.

That said, the stock’s yield is more than 50 basis points higher than its five-year average, leading back to my earlier point on the dynamic between undervaluation and a higher yield.

And if you find yourself to be a younger investor, the overall dividend metrics are strong.

However, we don’t invest in where a company has been; we invest in where a company is going.

And so we need to build those future expectations in terms of business and dividend growth, which will also help us later value the business.

But building that future expectation does require looking at what a company has done over a long period of time (using 10 years as a proxy for the long term), as it gives us some frame of reference.

We’ll then compare long-term, historical business growth results with a near-term forecast for profit growth.

When combined and blended together, we should have a pretty good idea as to where TJX Companies is going as a business, which should also tell us a lot about what to expect in terms of dividend growth moving forward.

The company increased its revenue from $18.337 billion to $33.184 billion from fiscal years 2008 to 2017. That’s a compound annual growth rate of 6.81%.

That is, in my opinion, attractive top-line growth.

Based on its market cap of ~$48 billion and its market position/scale, this is a pretty mature company.

With that size, I’d be pretty happy with ~5% revenue growth, yet TJX Companies exceeded that by a pretty wide margin.

Meanwhile, the company’s earnings per share grew from $0.83 to $3.46 over this period, which is a CAGR of 17.19%.

Incredible bottom-line growth here.

We can now see why the payout ratio hasn’t expanded that much. The company has simply grown its EPS at a rate that has nearly kept up with dividend growth over the last decade.

The excess bottom-line growth was driven by equally-impressive margin expansion and share buybacks.

Net margin for the most recent FY came in at almost 300 basis points higher than what the company registered 10 years ago.

And the outstanding share count is down by ~29% over this 10-year stretch.

Looking forward, CFRA believes TJX Companies will compound its EPS at an annual rate of 12% over the next three years.

While that would be a drop from what we see above, it would still be a very strong and meaningful amount of growth, especially in an era where it’s almost thought to be “online or die”.

Furthermore, it would provide an environment that’s ripe for like (or greater) dividend growth.

As I noted earlier, double-digit dividend growth for the foreseeable future seems likely.

If the business doesn’t appear to be impressive thus far, consider that the blistering growth has occurred even while the company maintained a stellar balance sheet.

While many businesses have levered themselves aggressively over the last decade, TJX Companies has a level of debt that is very low.

This is demonstrated by a long-term debt/equity ratio of 0.49 and an interest coverage ratio over 60.

Plus, the company’s cash and cash equivalents exceeds total long-term debt.

Looking at profitability, the company’s ability to differentiate itself and provide a unique experience to shoppers has translated into relatively strong metrics here, especially considering this is a sizable retail chain selling discount merchandise.

Over the last five years, TJX Companies has averaged net margin of 7.41% and return on equity of 53.41%.

Both numbers have expanded substantially over the last decade. And ROE is stratospheric without the benefit of a leverage boost.

Fundamentally, this appears to be one of the strongest retailers in the entire industry.

And its unique position differentiates itself for customers, as the experience isn’t really possible without actually visiting a store and bargain hunting.

As such, it should be no surprise is secular in a way that other retailers find it almost impossible to match. Its consistency – especially in regard to comps – is a hallmark of a wonderful business.

This bodes well for future dividend growth, as double-digit dividend increases seem all but guaranteed for the foreseeable future.

However, the company’s unique retail position also means it has to maintain its inventory just right, as any degredation in the customer experience (be it through quality, assortment, on-trend fashion, value, etc.) can eat into the company’s economic moat.

All in all, I think this is a very high-quality business.

But even a great business isn’t worth any price. Is the stock attractively valued right now?

The stock is trading hands for a P/E ratio of 20.80 right now. That’s a below-market P/E ratio on a company that is growing at an above-average rate. It’s also below the industry average. But it is roughly in line with the stock’s own five-year average P/E ratio.

Investors are paying much less for the company’s cash flow, relative to the three-year average.

And the yield, as discussed earlier, is significantly higher than its recent historical average.

So there is evidence the stock is undervalued right now, but what might a rational estimate of its intrinsic value be?

I valued shares using a two-stage dividend discount model analysis.

The two-stage model was used due to the relationship between (low) yield and (high) growth.

I factored in a 10% discount rate, a 10-year dividend growth rate of 15%, and a long-term dividend growth rate of 7%.

This is, in my opinion, a reasonable (if conservative) look at the company’s near-term and long-term dividend growth potential.

I’m modeling in the long-term demonstrated DGR, long-term EPS growth, wherewithal and penchant for double-digit dividend growth, near-term forecast for EPS growth, and modest payout ratio.

The DDM analysis gives me a fair value of $85.63.

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 the stock appears to be at least moderately undervalued, as even a slowdown in EPS and dividend growth would make the stock cheap here. But my valuation is limited to my own perspective, which is why I like to compare my viewpoint with what professional stock analysts conclude.

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 TJX as a 4-star stock, with a fair value estimate of $87.00.

CFRA 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.

CFRA rates TJX as a 3-star “HOLD”, with a fair value calculation of $79.55.

I came out somewhere in the middle here. Averaging the three numbers out gives us a final valuation of $84.06, which would indicate the stock is possibly 9% undervalued right now.

Bottom line: TJX Companies Inc. (TJX) is a uniquely-positioned and high-quality retailer, which has shown an ability to largely insulate itself from some of the structural issues plaguing many B&M retailers. Incredible business fundamentals, more than two decades of dividend growth, a strong possibility of double-digit dividend growth for the foreseeable future, and the potential that shares are 9% undervalued all adds up to a very compelling long-term dividend growth investment idea.

— Jason Fieber

Note from DTA: How safe is TJX Companies’ (TJXdividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 84. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, TJX Companies’ dividend appears very safe with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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