In the past few years, some biotechnology companies have become dividend payers. One of the largest, Amgen (AMGN), just increased its dividend almost 27%, giving it a new yield of about 2.8%.
Amgen is A-rated for dividend safety by Safety Net Pro. Under their cash-flow-based method of analyzing dividend safety, AMGN’s dividend is considered to be extremely safe.
Let’s see whether Amgen is well valued for a possible purchase by applying my usual 4-step process.
Step 1: FASTGraphs Default Valuation
The first step is to compare the stock’s current price to FASTGraphs’ default estimate of its fair value.
That default estimate is based on a price-to-earnings (P/E) ratio of 15, which is the long-term historical average for the stock market. This fair value is shown by the orange line on the following graph.
The black line is Amgen’s actual price. From the graph, we can see that Amgen is trading about 9% below its fair value under this method of appraisal. In other words, it is a little undervalued but still in the “fair” zone. I require a stock to compute as 10% beneath fair value before I will label it “undervalued.”
Also notice on the graph that Amgen just began paying dividends 6 years ago, as shown by these two markers:
• The light green area at the top indicates the amount of earnings paid out in dividends.
• The light gray line near the bottom shows Amgen’s dividend payout ratio from earnings.
Amgen has raised its dividend every year since it began paying dividends, so Amgen is a Dividend Challenger on David Fish’s list of Champions, Contenders, and Challengers. It has a dividend increase streak of 6 years. (The first year of dividend payments counts as the first year of the streak.)
Step 2: FASTGraphs Normalized Valuation
In the second step, we compare Amgen’s current P/E ratio to its long-term average P/E ratio. This helps adjust for the fact that many stocks typically trade at valuations above or below the default P/E ratio of 15 that we used in the first step.
Amgen’s valuation has changed a lot over the years. FASTGraphs’ data goes back 18 years, and over that span, AMGN’s average P/E ratio has been about 24.[ad#Google Adsense 336×280-IA]But it has gone down since than, and using 24 would make Amgen appear very undervalued, when in fact that may not reflect the market’s current view of the stock.
To be conservative, I will choose a shorter time period – 10 years.
That includes the Great Recession and spans the time since Amgen began paying dividends.
For that period, AMGN’s P/E has been 14.1.
So the stock’s valuation is just slightly below fair value by this method.
I calculate the percentage of undervaluation simply by dividing the current P/E ratio by the “normal” P/E ratio: 13.7 / 14.1 = 0.97 = 3% undervalued. That suggests a fair price of $144 / 0.97 = $148.
Step 3: Morningstar Star Rating
Morningstar uses a comprehensive net present value (NPV) technique for valuation. Many investors consider this approach to be the gold standard for valuing stocks.
On Morningstar’s 5-star grading scale, 5 stars means that Morningstar believes that AMGN is far undervalued. In fact, Morningstar places a fair value of $194 on the shares, which makes them 26% undervalued by their method.
Step 4: Current Yield vs. Historical Yield
Finally, we compare the stock’s current yield to its historical yield. The higher the stock’s current yield compared to its historical average, the better value it represents.
This chart looks backwards – showing “trailing 12-month” yield – so it displays AMGN’s dividend yield as 2.3% rather than its new forward yield of 2.8% after its most recent increase.
Even ignoring the increase, Amgen’s yield is the highest it’s ever been. Indeed it is about double the stock’s average yield over the past 5 years.
Again, to be conservative, we won’t use that ratio for valuation purposes. But we can use a number like 15%-20% as indicative of Amgen’s undervaluation by this approach.
Using 15% to represent the degree of undervaluation, we get a fair price of $169.
Using the 4 approaches just described, our valuation for AMGN looks like this:
My conclusion is that Amgen is undervalued at the present time. Its current price of about $144 is 14% beneath its fair value price of $167. That is an attractive entry point.
Note that this is not a recommendation to buy Amgen. Always perform your own due diligence on every potential purchase. Check out the company’s quality, financial position, and business prospects. Also consider whether it fits into your portfolio and how it might help you meet your long-term investing goals.
I do not own Amgen at the current time.
— Dave Van Knapp[ad#wyatt-income]