Price and value.
One represents what you pay, the other represents what you get in return.
Stocks are really no different than anything else in life in this regard.
Just like you can find the same exact refrigerator at different prices if you perform an in-depth search around the internet and your local stores’ inventories, the price of stocks vary quite a bit in regards to their intrinsic value. In fact, it’s even more obvious with stocks since their prices fluctuate every single trading day.
But do values fluctuate like this?
[ad#Google Adsense 336×280-IA]Does seeing the same refrigerator priced $50 higher at one appliance store than everywhere else all of the sudden mean it’s now worth $50 more?
And this is why it’s important to value stocks, which is where Dave Van Knapp’s guide on stock valuation comes into play.
If you’re looking for help on separating price from value, this is a great tutorial.
It’s never a good idea to overpay for anything in life, but that’s especially true when it comes to dividend stocks.
Overpay for a dividend stock and not only are you wasting money by exchanging the potential for capital gains for capital losses, but you’re also locking in a lower yield upfront which can haunt you for the rest of the time you own that stock.
Carefully valuing stocks is a hallmark of my strategy, which has allowed me to build a six-figure portfolio in three years on a very modest income.
As such, I’m always on the lookout for high-quality dividend growth stocks priced at or below their intrinsic value.
And the best place I know of to look for dividend growth stocks is David Fish’s Dividend Champions, Contenders, and Challengers list, which is a document that tracks more than 600 US-listed stocks with at least five consecutive years of dividend increases.
I recently found a stock on Mr. Fish’s list that appears to be substantially undervalued.
Read on to find out which stock it is!
BHP Billiton PLC (BBL) is the world’s largest diversified resources company. They’re engaged in the exploration, development, processing, and production of a number of minerals. They also have a substantial oil & gas business.
One might not immediately think of a diversified resources company as a stout dividend growth stock, but surprisingly enough, that’s exactly what BBL is.
They’ve increased their dividend for the past 12 consecutive years, which includes the Great Recession and the global slowdown that followed.
It’s not just the length of their record that might be surprising, but also the rate at which they’ve grown the dividend – the five-year dividend growth rate is 8.1%.
Check this out.
The yield is an eye-popping 5.29% right now.
Sure beats the interest offered down at your local bank, right? Keep in mind as well that the five-year average yield for BBL is only 3.6%, so there could be an incredible opportunity here.
The payout ratio is moderately high at 66.3%, however, which, while not concerning, is something to keep an eye on.
So shares offer a monster dividend that’s growing.
But what about the rest of the business?
We’ll see what kind of growth BBL has managed over the last decade, which will also help us with valuing the business.
The company has grown revenue from $29.587 billion in fiscal year 2005 to $67.206 billion in FY, which is a compound annual growth rate of 9.54%. Obviously, this is an incredibly impressive considering that it’s coming off of a large base and the Great Recession occurred during this time frame; however, there was also a massive commodity boom during the last 10 years as well which is showing signs of slowing considerably.
Meanwhile, earnings per share increased from $2.08 to $5.18 over this stretch. That’s a CAGR of 10.67%, which is equally impressive. But, like revenue, EPS is retreating due to supply and demand concerns across major resources, and TTM EPS is significantly lower.
S&P Capital IQ is anticipating that EPS will grow at a 3% compound annual rate over the next three years, which seems to reflect the weakening global commodity market.
BBL maintains a spectacular sheet, considering their size and business. The long-term debt/equity ratio 0.38 and the interest coverage ratio is over 38 as of the last fiscal year. These are really great numbers.
Profitability also indicates the high-quality nature of this firm, far exceeding any peers. The miner has posted net margin that’s averaged 23.43% over the last five years and return on equity of 27.22%. Really incredible results.
BBL’s business is high quality and the financial metrics across the board are nothing short of fantastic, though the global market for the resources BBL offers has weakened lately. That said, a potential upcoming spin-off involving certain aluminum, thermal coal, nickel and other assets could add even more value for shareholders.
So is this stock a good value?
Shares trade hands for a P/E ratio of 12.52, which is in line with their five-year average.
But what’s the business worth?
I valued shares using a dividend discount model analysis with a 10% discount rate and just a 5.5% long-term growth rate, which is fairly conservative given BBL’s track record. But it seems prudent to be conservative here considering the business model and the cyclical nature of commodity demand and pricing. The DDM analysis gives me a fair value of $58.14 for this stock.
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 appears that the stock is considerably undervalued from what the DDM analysis shows, but let’s also take a look at what some professional analysts think about this stock and 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 BBL as a 4-star stock, with a fair value estimate of $60.00.
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 BBL as a 3-star “hold”, with a 12-month price target of $44.00.
Averaging out these three numbers so as to come to some kind of consensus gives us a final fair value of $54.05. That’s a full 15% higher than where shares trade at right now, which means this stock is potentially substantially undervalued right now.
Bottom line: BHP Billiton PLC (BBL) is a high-quality company across the board that currently provides a very attractive yield. However, a drop in prices almost across the board for major commodities means BBL may slow over the short term. However, a potential upcoming spin-off, strong current income, and what appears to be significant undervaluation would seem to indicate that the possible long-term rewards far outweigh the short-term rewards. I’d strongly consider BBL and the 15% upside this stock could offer.
— Jason Fieber, Dividend Mantra