There’s a pretty massive wealth gap in the United States.
The chasm between the rich and the poor is huge – and growing.
Feeling powerless, people wait for politicians, business leaders, or even their employers to somehow make up the difference.
Well, that strategy won’t really get you anywhere.
Dividend growth investing.
Dividend growth investing is an amazing long-term investment strategy.
It essentially involves buying shares in some of the best businesses in the world.
More specifically, one buys stocks that have a lengthy track record of paying their shareholders growing dividends, which are funded by the growing profit these fantastic businesses are producing.
One can find more than 800 different dividend growth stocks on David Fish’s Dividend Champions, Contenders, and Challengers list – a compilation of data on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
One can build not only a tremendous amount of wealth by slowly but surely buying high-quality dividend growth stocks, but they can also build a huge stream of reliable and growing passive income.
And it’s this growing dividend income that can unlock financial independence for someone, which could allow them to bridge that gap and live a lifestyle that’s typically reserved for the wealthy.
That’s because it is.
In fact, I was once on the poor side of the chasm.
I was a broke and unemployed college dropout less than 10 years ago.
That process unfolded into a multi-year journey toward FIRE (financial independence/retired early) that I laid out in my Early Retirement Blueprint.
The end result of that saving and investing is my FIRE Fund – my real-money and real-life dividend growth stock portfolio that generates the five-figure and growing passive dividend income I need to pay my bills in life.
I crossed that chasm – going from below broke to FIRE in about six years.
All that said, you don’t want to blindly buy random dividend growth stocks off of Mr. Fish’s list.
Not every business is the same. And even a great business can command a price that’s too high for reasonable investment.
So you have to make sure to do your due diligence, checking over fundamentals, competitive advantages, and risks before investing your capital.
You also have to understand the valuation a stock is available at.
That’s because valuation can have a major impact on your investment’s performance, especially over the short term.
While price is what you pay, value is what something is actually worth.
Seeing the distinction between the two is vital to long-term investment success.
An undervalued dividend growth stock should offer an investor a higher yield, greater long-term total return potential, and less risk.
That’s all relative to what the same stock might otherwise present if it were fairly valued or overvalued.
Price and yield are inversely correlated; all else equal, a lower price will result in a higher yield (and thus more investment income).
That higher yield gives long-term total return potential a boost right off the bat, as total return is comprised of two components: capital gain (price appreciation) and investment income (via dividends or distributions).
Meanwhile, capital gain is also given a possible boost via the “upside” that exists between a lower price paid and higher intrinsic value of a stock.
If the market realizes the full value of a stock that’s bought when it’s undervalued and reprices it accordingly, that’s extra capital gain on top of whatever organic upside/capital gain that will come about as a business naturally becomes worth more through the process of increasing its profit.
These dynamics have a way of reducing risk, too.
That’s because you introduce a margin of safety when paying less than what something is worth.
Just in case an investment thesis turns out wrong (a business might not perform as expected for a myriad of reasons), undervaluation protects downside (an investment ending up worth less than the price paid).
It’s fairly clear that undervaluation is far more preferable than overvaluation or even fair value.
Fortunately, it’s not terribly difficult to estimate the intrinsic value of just about any dividend growth stock out there.
Fellow contributor Dave Van Knapp set out to simplify that process via Lesson 11: Valuation, which is the 11th chapter in his series of lessons that are designed to help educate investors on what dividend growth investing is and how to successfully use the strategy to one’s advantage.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
TJX Companies Inc. (TJX)
TJX Companies Inc. (TJX) is an operator of off-price apparel and home fashions retail chain stores in the US and certain international markets.
By business segment, FY 2018 sales break down as following: Marmaxx (US), 62%; HomeGoods (US), 14%; TJX International (Europe & Australia), 14%; and TJX Canada, 10%.
This is the largest off-price apparel and home fashion retailer in the United States, which confers a certain level of scale, purchasing power, efficiency, and brand recognition in a very unique and niche 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.
This business model is quite unique in the retail space. That should continue to protect the chain in the face of increasing retail sales moving online.
That uniqueness is related to the off-price apparel and home fashion it retails, as these are pieces that aren’t typically offered anywhere else for the price.
The stores offer a “treasure hunt” experience that simply cannot be replicated online – customers search through the bins and racks for right-sized and right-priced offerings, and this process has to play out in person.
It’s that experience customers crave that has thus far protected the company, with TJX Companies expanding and doing incredibly well in an era where the big retail story is truly e-commerce.
That bodes well for the company and its shareholders, especially considering that the company’s own e-commerce efforts have more or less gone nowhere (due to the very nature of the dynamics laid out above). Less than 1% of sales is generated from the company’s e-commerce platforms.
What also bodes well for shareholders is the company’s commitment and wherewithal as it relates to paying a growing dividend.
The company has raised its dividend for 22 consecutive years.
If that’s not enough to like, consider the fact that the 10-year dividend growth rate is sitting at a monstrous 21.6%.
Double-digit dividend growth over the course of a decade is a really wonderful sight to see, as it usually indicates that underlying profit growth has also been fairly strong over the same period.
But you often see a marked deceleration in near-term dividend growth in these cases.
However, that’s not the case here.
It’s actually been the opposite. Dividend growth has recently accelerated.
The five-year dividend growth rate is 22.2%. And the most recent dividend increase was almost 25%!
And with a payout ratio of just 38.6%, there’s still plenty of room for the company to continue aggressively increasing its dividend.
The only real drawback to the dividend metrics might be the current yield.
At just 1.86%, there’s not a lot of current income to be had for older investors who are in need of that dividend income for lifestyle purposes.
But that yield is almost 70 basis points higher than its five-year average.
If you’re a young investor who has time to let that dividend growth compound in your favor, there’s a lot to like here.
That thesis translates well to the company’s top-line and bottom-line growth: TJX Companies has done an admirable job at growing its business over the last decade.
We’ll now take a look at exactly what that looks like.
And we’ll compare that 10-year result with a near-term forecast for profit growth.
Combining these numbers should give us a high-level look at what TJX Companies is capable of, which should tell us a lot about dividend growth moving forward.
All of that information should in turn allow us to reasonably estimate the stock’s intrinsic value.
TJX Companies has increased its revenue from $19.0 billion in fiscal year 2009 to $35.865 billion in FY 2018. That’s a compound annual growth rate of 7.31%.
Rather impressive top-line growth here.
I’d generally have a baseline expectation for mid-single-digit revenue growth, but the business clearly outstripped that.
Meanwhile, earnings per share advanced from $1.00 to $4.04 over this same period, which is a CAGR of 16.78%.
There’s a large gap there between the two growth rates.
That’s explained by the company’s prodigious buybacks, which simultaneously occurred while the company was expanding its margins.
For perspective on the buybacks, the company’s outstanding share count is down by about 27% over the last decade. And the company recently announced its intentions to repurchase between $2.5 and $3 billion of common stock over the near term, which would translate into approximately 6% of the outstanding shares.
And net margin has expanded by over 200 basis points over the last decade.
It’s a business that has been run incredibly well. Quite prolific, really.
Looking out over the next three years, CFRA is calling for TJX Companies to compound its EPS at an annual rate of 8%.
That would be a pretty noticeable deceleration in EPS growth, if it were to come to pass.
CFRA sees margin pressure from higher SGA expense, which will be negatively impacted by higher wages and certain investments in the business.
But the lower tax rate, huge buyback plan, and unique position in the market should offset those concerns.
Either way, the company should grow at a very acceptable rate moving forward.
Even if they were to compound their EPS at an 8% annual rate over the next three years (a figure I believe is very conservative), the dividend could grow at 10%+ annually without a problem by virtue of the low payout ratio. Longer term, the picture looks even better.
What’s also quite bright about this company’s picture is its balance sheet.
The balance sheet is phenomenal.
The long-term debt/equity ratio is 0.43, while cash on hand exceeds long-term debt.
Moreover, the interest coverage ratio is over 60.
Profitability is also very strong.
Over the last five years, the company has averaged annual net margin of 7.39% and annual return on equity of 53.12%.
That profitability is made to look even more robust when you consider the lack of leverage.
Overall, I see almost nothing to like about the business.
It’s being run about as well as a business can be run. Management should be proud.
The growth is stellar, the balance sheet is a pillar of strength, the business model serves as a competitive advantage in and of itself, and the dividend growth track record is nothing short of highly impressive.
Of course, the company does have competition.
And any major bump in the economy could affect consumer discretionary spending.
Also, the company’s international exposure is a bit light. 76% of FY 2018 sales came from US business segments. And the international sales are not growing as fast as domestic, prompting questions as to how well this concept translates overseas.
Overall, though, there’s just so much to like about the company. It’s obviously a high-quality business.
But even a high-quality business isn’t worth any price. Is the valuation appealing right now?
The stock is trading hands for a P/E ratio of 20.76. That compares very favorably to the broader market. And it’s also lower than the stock’s own five-year average P/E ratio of 21.1.
The P/S ratio is also lower than its own five-year average.
And the yield, as noted earlier, is quite a bit higher than its recent historical average.
So the stock does look at least modestly undervalued, but what might that look like? What would a reasonable estimate of 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%.
The near-term DGR is quite a bit lower than what the dividend has already grown at over both the near term and long term.
And I’d argue the dividend has the potential to grow at a much higher rate than 7% looking out past a decade.
But I like to err on the side of caution, especially considering that the entire retail world is in upheaval right now.
The DDM analysis gives me a fair value of $106.87.
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.
The stock doesn’t appear to be massively undervalued, but we have what looks like a high-quality dividend growth stock available at a price below intrinsic value (even after a conservative valuation).
However, we’ll compare what I came up with to that of what two select professional analysis firms have concluded in terms of this stock’s valuation. That should add depth, balance, and perspective to our conclusion.
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 3-star stock, with a fair value estimate of $90.00.
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 4-star “BUY”, with a 12-month target price (used in lieu of FV) of $86.00.
I came out the highest. Nonetheless, there’s a consensus here that agrees the stock is worth more than its price. Averaging the three numbers out gives us a final valuation of $94.29, which would indicate the stock is potentially 12% undervalued right now.
Bottom line: TJX Companies Inc. (TJX) is one of the highest-quality companies I’ve ever come across. The fundamentals are incredible across the board. And the business has the capability to grow its dividend at well into the double digits for years to come. More than 20 consecutive years of dividend raises, a massive near-term buyback program, a recent 25% dividend increase, and the possibility of 12% upside indicates this might be one of the best opportunities in retail for dividend growth investors right now. The stock is about as off-price as the company’s merchandise.
Note from DTA: How safe is TJX’s dividend? 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’s dividend appears very safe with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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