The stock market isn’t offering a lot of opportunity right now.
The S&P 500 index is up an absolutely massive 87.67% over the last five years, which means most stocks in the market have also been on tears over that period.
Notice I said most.
The stock market is like any other market. You’ve got a lot of merchandise there. And the S&P 500 index is representative of just the 500 largest stocks listed on the NYSE and Nasdaq.
Meanwhile, there are thousands of publicly listed stocks available for US investors.
The key is to avoid stocks that are overvalued and buy stocks that are undervalued.
But how do you do that?
Well, you first have to learn how to value stocks in the first place.
If this is something you need some brushing up on, I recommend Dave Van Knapp’s valuation guide.
The reason you want to buy stocks that are undervalued are the same as the reason you want to buy anything in life as cheap as possible. It’s all about minimizing cash outlays and maximizing wealth.
And while scoring a sale on a loaf of bread at your local grocery store whereby you’re able to pick up a loaf for $1 when it’s really worth $2 is a great example of this, buying cheap stocks is much more powerful. Saving $1 is a one-time event. But buying a dividend growth stock for less than it’s worth is something that can compound for you for the rest of your life.
That’s because a stock’s price and its yield are inversely correlated, meaning the cheaper the price, the higher the yield. And a higher yield compounds at a greater rate over a long period of time.
It’s because of this that I’m always interested in finding high-quality dividend growth stocks on sale that I can add to my portfolio.
I routinely search David Fish’s Dividend Champions, Contenders, and Challengers list for excellent dividend growth stocks that appear to be priced below their intrinsic value.
And I believe I found one. Let’s check it out, shall we?
Core Laboratories N.V. (CLB) provides proprietary and patented reservoir description to oil and gas companies so as to enhance production.
This company operates in more than 50 countries throughout the world and has been in operation for more than 70 years.
Their geological expertise and experience puts them in a unique position to deliver the best possible results for their clients. Oil companies are always interested in maximizing production, and the better a company can understand their reservoirs, the more they should theoretically produce. And since cheap oil is long behind us, making sure every asset is efficient as possible means Core Laboratories should continue to benefit.
The company initiated its dividend in 2008, so it doesn’t have a lengthy dividend growth record like some stalwarts in the energy sector. But seven consecutive years of dividend raises could be the start of something much lengthier.
And it gets better.
The five-year dividend growth rate is an astounding 58.5%.
That’s among the highest I’ve ever seen.
Yielding 2.08% right now, which is attractive, you’ve got both a solid yield and huge growth.
And the payout ratio is just 38.7%, indicating that there is plenty of room for future dividend raises going forward.
These dividend metrics here are some of the most impressive you’ll find, especially the dividend growth rate. You can generally assume the sum of a stock’s yield and its dividend growth rate as a proxy for total returns over the long term, assuming a static valuation. And you see that with CLB, as the stock is up some 844% over the last 10 years!
Seeing dividend growth that high with a moderate payout ratio would tell us the company’s underlying profit has also grown substantially, so let’s take a look at that. Researching their growth and fundamentals will give us some insight as to what the company is ultimately worth.
Revenue grew from $427 million to $1.074 billion from fiscal years 2004 – 2013. That’s a compound annual growth rate of 10.79% over the last decade. So the top line has been growing at a very healthy clip.
But what about their profit? Taking in a lot of revenue is wonderful, but it won’t get you very far if you’re not profiting.
Earnings per share increased from $0.22 to $5.28 over this time frame, which is a CAGR of 42.35%. Ahh, so we see now that the huge dividend growth has been indeed supported by massive growth in profit. This is extremely impressive.
S&P Capital IQ is calling for 17% compound annual growth in EPS over the next three years. That’s a slower rate than what the company has posted over the last decade, but still more than enough to propel great returns and dividend growth.
The company’s balance sheet is in great shape. Though the long-term debt/equity ratio appears high, at 1.58, this appears more due to low common equity than a high absolute amount of debt. The company sports an interest coverage ratio of 35.79, which is actually rather high. That means EBIT can cover interest expenses more than 35 times over.
Perhaps what’s most impressive of all is their profitability. Net margin has averaged 19.96% over the last five years, while return on equity has averaged 87.81%. The low common equity is boosting the ROE, but every single profitability metric is absolutely fantastic here. They’re just showing off when you see that return on invested capital was 59.01% last year.
Fundamentally, this is about as sound as a company can possibly get. It’s impressively operated at almost every level. The only drawback is that energy has been hit hard over the last six months. But that drawback is countered by the fact that CLB’s stock has also dropped in tandem, thus reducing the valuation quite a bit.
And that valuation is evident in the stock’s P/E ratio, sitting at 18.56 right now. That seems pretty low for a company growing at this rate, and compares extremely favorably to their five-year average ratio of 30.2.
But what is this stock actually worth? What should we pay?
I valued shares using a dividend discount model analysis with a 10% discount rate and an 8% long-term growth rate. That rate is about as aggressive as I go looking out over the long haul, but the low payout ratio and aggressive EPS growth should be able to support substantial dividend growth for many years to come, unless an unforeseen fundamental issue develops. The DDM analysis gives me a fair value of $118.80.
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.
It would appear that, based on the current price, there’s a sizable margin of safety here in shares. But my analysis isn’t the only analysis out there. Let’s see what some professionals that follow this stock think about its valuation.
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 CLB as a 4-star stock, with a fair value estimate of $146.00.
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 CLB as a 4-star “buy”, with a 12-month target price of $149.00.
I sometimes come in at the high end of these estimates, but it looks like I was actually quite conservative this time around. If you average out the three numbers so as to come to one final conclusive fair value, we get $137.93. That would indicate that this stock is potentially 30% undervalued right now.
Bottom line: Core Laboratories N.V. (CLB) is a high-quality firm that has access to years of proprietary and patented geological information that major oil producers need in order to maximize production. This information is extremely valuable and very difficult for any competitor to replicate. Their growth is off the charts and the fundamentals are about as impressive as they come. This stock seems abnormally cheap, which is potentially unwarranted. I would strongly consider this stock right now.
— Jason Fieber, Dividend Mantra