Undervalued Dividend Growth Stock of the Week: Comcast Corp. (CMCSA)

If you want to build lasting wealth for the long haul, it makes sense to invest in obvious, profitable, and ubiquitious long-term trends.

There are a number of obvious and omnipresent trends that exist all around us, and many of these trends are quite clearly here to stay for a very long period of time.

While not every trend is profitable – at least not initially – many are.

What’s great about this is that it’s easy to capture pieces of those rising tides lifting all boats by jumping on a boat – or dozens of boats, preferably.

What do I mean by that? 

Well, it’s easy to invest in some of the world’s best businesses that are out there taking advantage of profitable long-term trends.

Better yet, many of these great businesses are so prolific at producing profit that’s regularly increasing (as tends to happen when you’re providing the world with the products and/or services it clearly craves), they share a good chunk of that growing profit with their shareholders via growing dividends.

Buying and holding stock in these companies can result in a lot of growing wealth and passive dividend income over the long run.

We’re generally talking about high-quality dividend growth stocks here.

And you don’t have to look far to find these stocks.

You can find more than 800 US-listed stocks that have paid rising dividends each year for at least the last five consecutive years, by checking out the late, great David Fish’s Dividend Champions, Contenders, and Challengers list.

Although David’s CCC list was last updated on April 30, 2018 (due to his untimely passing), it is still chock-full of incredible information.

It’s the ultimate resource for anyone out there looking to invest in not just great companies that are taking advantage of global trends, but great companies that are “spreading the wealth” by paying their shareholders regular, reliable, and growing dividends.

I talked about jumping on many boats that are being lifted by rising tides.

Well, I’ve essentially jumped on more than 100 “boats” by investing in more than 100 of the world’s best businesses.

Jason Fieber's Dividend Growth PortfolioI hold all of my personal equity investments in my FIRE Fund, which is my personal stock portfolio.

By buying up that many high-quality dividend growth stocks, I’m able to cast a wide net and participate in the rising tides across many fantastic long-term trends.

What’s really wonderful about it is, that portfolio generates the five-figure and growing dividend income I need to cover my basic expenses in life, rendering me financially independent in my 30s.

And I built that portfolio, passive dividend income, and freedom while working a regular, middle-class, blue-collar job. Oh, and I did it in six years.

How all of that occurred has been laid out in my Early Retirement Blueprint, which is a road map that just about anyone can follow so that they, too, can become financially independent/retired early (FIRE).

As great as all of this is, though, one needs to be thoroughly diligent before they actually buy stock in a company.

You need to analyze and value a stock before even thinking about buying it.

That latter part – valuation – is particularly important.

Even a great stock can be a relatively poor investment, especially over the short term, if the price paid at the time of investment is way too high (i.e., overvalued).

On the other hand, undervaluation (when price is well below estimated intrinsic value) can lead to substantial benefits.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and less risk. 

That’s all 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.

And that higher yield goes on to positively impact total return, leading to greater long-term total return potential.

That’s because yield is one of two components of total return.

Capital gain is the other component.

Fortunately, that second component is also given a possible boost via the “upside” that exists when there’s a major and advantageous disconnect between price and value.

While price and value can be extremely mismatched over the short term, they tend to pretty closely correlate over the long term. Buying when the disconnect results in undervaluation creates a bit of a “coiled spring” effect, which can skyrocket capital gain – and that’s on top of whatever capital gain is/was possible as a business naturally becomes worth more over time (as it increases its profit).

These dynamics have a way of reducing risk, too.

That’s because it’s clearly less risky to pay less than more.

You’re going to be risking less capital on a per-share basis when you pay less.

And you introduce a margin of safety when undervaluation is present, as it protects you against downside just in case your investment thesis is somehow incorrect.

After all, intrinsic value can be no more than an estimate. You want to buy in as far below your estimated number as possible. That gives you a greater allowance to be wrong.

And reducing downside simultaneously increases upside.

Buying a high-quality dividend growth stock when it’s undervalued can serve as a tremendous long-term investment.

But first you have to be able to actually value a stock.

Well, fellow contributor Dave Van Knapp has made the process of valuation much easier, which can greatly aid an investor when it comes time to value a prospective dividend growth stock.

Lesson 11: Valuation is the 11th lesson in his overarching series of lessons on all things dividend growth investing, and it’s this lesson that specifically focuses on valuation.

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…

Comcast Corp. (CMCSA)

Comcast Corp. (CMCSA) is a media and entertainment conglomerate with interests in cable, broadcasting, film, and theme parks.

I mentioned investing in obvious long-term trends at the outset of this article.

Well, they don’t get much more obvious than content consumption and Internet access. (“Content” includes articles, books, movies, music, shows, etc. Content provides information, knowledge, and entertainment.)

Content is consumed at a massive rate, if just in different formats than what existed a decade or two ago.

Part of that change has manifested through the power of the Internet. People can now stream high-quality content completely online, bypassing traditional connections (like broadcast networks and cable).

And the rise of the Internet has allowed everyday people to create their own content (with myself being an example of this phenomenon).

Indeed, due to the creator and consumer sides in content, the Internet is extremely necessary to content production, distribution, and consumption.

Well, Comcast has all of that locked down.

That’s because they produce and distribute content on a massive scale. And they also provide the necessary high-speed broadband Internet connections to millions of households.

They operate through two segments: Cable Communications (60% of FY 2017 revenue) and NBCU (40%).

Cable Communications provides more than 22 million cable video connections, more than 24 million high-speed Internet connections, and voice services to approximately 11 million customers.

That segment is effectively the distribution side of Comcast’s business model.

NBCU, meanwhile, comprises various cable networks (such as USA, E!, CNBC, and MSNBC), broadcast television (including NBC), filmed entertainment (including Universal Pictures and Dreamworks Animation), and theme parks (Universal Parks & Resorts).

This segment is effectively the production and entertainment side of the business model.

It’s interesting to note that the distribution side actually provides more revenue.

It’s that revelation that I think is important to keep in mind as we think about Comcast’s future viability as a company and its ability to pay a growing dividend.

Speaking of that growing dividend, let’s see what Comcast has already been up to.

They’ve increased their dividend for 11 consecutive years.

And the five-year dividend growth rate stands at a very impressive 14.9%.

Moreover, there hasn’t been any marked deceleration in dividend growth: the most recent dividend increase came in at over 20%.

And with a payout ratio of just 36.7% (on adjusted TTM EPS), there’s still plenty of room left for strong dividend growth for many years to come.

The stock yields a comfortable 2.36% right now.

That’s a bit above the broader market, making it relatively attractive.

More importantly, it’s well above the industry average.

And it’s more than 70 basis points higher than the stock’s own five-year average yield.

The dividend metrics are pretty appealing across the board.

But in order to estimate future dividend growth, which greatly aids us when it comes time to value the stock, we must first look at business growth.

So we’ll next see what Comcast has done over the last decade (a proxy for the long term) in terms of revenue and earnings per share growth.

And we’ll compare that to a near-term professional forecast for EPS growth.

Knowing where Comcast has gone, and where it might be going, will tell us a lot about what to expect from the dividend moving forward.

The company has increased its revenue from $34.423 billion to $84.526 billion between fiscal years 2008 and 2017. That’s a compound annual growth rate of 10.50%.

Awfully impressive, especially with the starting size of revenue. To grow that much off of a base of more than $34 billion is pretty incredible.

However, Comcast has largely grown revenue through acquisitions over this period, particularly through the NBCU acquisition from General Electric Company (GE).

Relative growth (by factoring in profit on a per-share basis) will tell us a lot more about what’s really transpired here.

Comcast grew its EPS from $0.43 to $2.06 over this same period, which is a CAGR of 19.01%.

That $2.06 is looking at adjusted EPS for FY 2017. Due to 2017 tax reform in the US, Comcast recorded a much larger GAAP EPS result, but this one-time anomaly isn’t indicative of the company’s actual earnings power.

Revenue growth, which is looking total, absolute growth was impressive. But the bottom-line growth, which factors in growth on relative basis, was even stronger.

What’s happened here is, Comcast has become a much better business across the board. Plus, they bought back a lot of shares.

The outstanding share count is down by over 18% over the last decade. And the company expects to buy back at least $5 billion in stock over the course of 2018.

Furthermore, profitability across the board has greatly improved over the last 10 years. Net margin has expanded handsomely.

Looking forward, CFRA is predicting that Comcast will be able to compound its EPS at a 16% annual rate over the next three years.

While a bit short of what’s occurred over the last decade, that would still be pretty incredible by any measure.

CFRA cites the large buybacks, a boost in potential capital allocation due to tax reform, increased traffic at theme parks (bolstered by new attractions), and a higher penetration of residential and business bundles.

One big near-term question mark regarding Comcast and its growth is the announced $31 billion offer for Sky PLC (a leading entertainment and communications company in the UK).

Moving over to the balance sheet, this is, in my view, one of the biggest weaknesses of the business.

It’s not a terrible balance sheet, but I don’t think it’s particularly attractive or strong, either.

The long-term debt/equity ratio is 0.86, which isn’t really a problem.

However, cash on hand is a small fraction of long-term debt.

The real issue with the debt, though, is the interest coverage ratio, which stands at just under 6.

I went back quite a few years and found that Comcast has operated with a balance sheet like this for a long time. So they’ve done well with that, and they’re obviously experienced in terms of operating a leveraged business and executing.

Profitability, as quickly touched on earlier, is quite robust. And there’s been a noticeable improvement of late.

Over the last five years, the company has averaged annual net margin of 14.27% and annual return on equity of 19.77%.

Both averages are artificially boosted by the one-time GAAP EPS gain for FY 2017, but keep in mind that Comcast was routinely registering net margin below 10% before FY 2013.

All in all, I think there’s a lot to like about Comcast.

The company reminds me a lot of Walt Disney Co. (DIS), which is my favorite media and entertainment company.

Comcast has the various cable networks, one of the big four US broadcast networks, the theme parks, and the studio entertainment.

But what Comcast has, that Walt Disney doesn’t, is the broadband Internet service.

And that’s a huge differentiation moving forward, especially as consumers become more comfortable with streaming content online.

While there’s a lot of concern and discussions regarding the “cord cutting” effect on cable companies’ bottom lines, the fact of the matter is that Internet access is becoming as important as breathing air to most consumers. More people demanding faster Internet access in the future is a very obvious and bankable long-term trend.

Cable companies know this. And whatever they stand to lose on the cable subscription side, they can more than make up with on the Internet access side.

The only problem with this dynamic, though, is that any cord cutting that does occur affects a company like Comcast disproportionately due to the fact that a lost subscriber means less revenue on both the distribution (the cable subscription) side and the production (the cable network subscriber numbers and affiliate fees) side.

Still, we can see what kind of growth Comcast has posted straight through one of the most turbulent and transitional periods we’ve ever seen in media.

Risks like competition, regulation, and the future of Internet delivery (like, say, 5G) remain, but Comcast remains positioned about as well as one can be.

And with a slide of 20% on the stock YTD, the valuation looks surprisingly compelling…

The P/E ratio is sitting at 15.59, which is obviously well below the broader market.

Furthermore, that compares very favorably to the stock’s own five-year average P/E ratio of 19.0.

Every other basic valuation metric (P/S, P/CF, P/B) is well below its respective recent historical average.

And the yield, as shown earlier, well above its five-year average.

The stock does look cheap here, but how much so? What’s a reasonable estimate of intrinsic value? 

I valued shares using a dividend discount model analysis.

I factored in a 10% discount rate.

And I assumed a long-term dividend growth rate of 8%.

That DGR seems very rational when you look at what the company has already produced over the last decade, how much they just raised the dividend buy, the ongoing buybacks, the low payout ratio, and the forecast for future EPS growth.

But all of that is moderated by a changing media landscape, a balance sheet that’s a bit less strong than I’d like to see, and the bid for Sky PLC.

The DDM analysis gives me a fair value of $41.04.

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 I believe we have a high-quality dividend growth stock that is at least moderately undervalued, perhaps severely so.

But let’s compare my valuation to that of what two select professional analysis firms have come up with, which will add depth 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 CMCSA as a 4-star stock, with a fair value estimate of $42.00.

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 CMCSA as a 4-star “BUY”, with a 12-month target price of $40.00.

We can see a pretty tight consensus here, with everyone agreeing that the stock is worth $40 or more. Averaging the three numbers out gives us a final valuation of $41.01, which is just pennies away from where I came out. That would indicate the stock is potentially 27% undervalued.

Bottom line: Comcast Corp. (CMCSA) is a massive, diversified, and well-positioned media and entertainment juggernaut. With valuable assets on both the production and distribution side of content, especially as it relates to high-speed Internet, the company should be able to continue capitalizing on obvious trends in consumer behavior. More than 10 consecutive years of dividend growth, a well-covered and relatively large dividend, and the potential that shares are 27% undervalued means this is a high-quality stock dividend growth investors should consider adding to their portfolios.

— Jason Fieber

Note from DTA: How safe is CMCSA’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 91. 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, CMCSA’s dividend appears very safe and extremely unlikely to be cut. Learn more about Dividend Safety Scores here.

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