You could work hard for money.

Or you could let money work hard for you.

Which way do you think is more effective and enjoyable? 

Money is far more effective at working.

It can work 24/7. And it can compound itself.

You can’t say that about yourself.

And it’s far more enjoyable to let money work for you because that frees you up to spend your time on passionate pursuits in your life.

The awesome thing about this is, it’s not easy to make that switch – to go from working for money, to your money working for you.

It just takes the simple action of investing.

More specifically, one should aim to regularly save and intelligently invest as much excess capital as possible, as soon as possible.

And the most intelligent way of investing I’ve yet to come across is dividend growth investing.

This simple strategy involves buying up equity in high-quality companies that directly reward their shareholders with a large chunk of profits the companies are producing.

Well, as the profit increases (which tends to happen when you’re dealing with high-quality companies), so should that return of profit.

That return of profit is a dividend.

And the regular and reliable payment of growing dividends to you can set the foundation of your financial independence.

You can find more than 800 US-listed dividend growth stocks via David Fish’s Dividend Champions, Contenders, and Challengers list – the most comprehensive collection of data on these stocks anywhere.

I personally used this strategy to go from below broke to financially independent in six years, which I laid out in my Early Retirement Blueprint.

And now my money works for me, because the five-figure and growing passive dividend income my FIRE Fund generates on my behalf covers my real-life bills.

But this can’t happen unless you get your money working for you, which is what today’s article is all about.

Jason Fieber's Dividend Growth PortfolioI’m going to take some time to highlight a high-quality dividend growth stock that looks compelling at today’s prices, going over its fundamentals, competitive advantages, risks, and, perhaps most importantly, valuation.

The valuation is incredibly important because the price you pay for a stock can and likely will greatly affect the performance of the investment, especially over the short term.

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.

Price and yield are inversely correlated; all else equal, a lower price will result in a higher yield.

Of course, a higher yield means more investment income in your pocket on the same dollar invested.

But it also means greater long-term total return potential, because investment income (through dividends or distributions) is one of two components of total return.

In addition, capital gain – the other component – is given a possible boost via the “upside” that exists between price and value when a stock is purchased at an undervalued level.

The market might not be accurate with pricing over the short run, but price and value do tend to more closely correlate over the long term.

And if you’re able to buy when undervaluation is present, that sets you up to take advantage of a repricing.

That can create a “coiled spring” effect on a stock.

And this also has a way of reducing risk, too.

That’s because you limit your downside when you maximize your upside.

You build in a margin of safety when you pay much less than intrinsic value.

And since intrinsic value is always just an estimate, it’s prudent to buy well under that number, for you don’t want to be upside down on an investment if your estimate is too high or if the thesis goes wrong.

Fortunately, it’s made to be much easier to estimate intrinsic value when you have a system that you follow.

Fellow contributor Dave Van Knapp has shared such a system with you readers, via a lesson in his guide to all things dividend growth investing.

It’s Lesson 11: Valuation.

This lesson homes in on valuation, and it’s a system that can be reliably replicated for just about any dividend growth stock out there.

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…

Amgen, Inc. (AMGN)

Amgen, Inc. (AMGN) is a global biotechnology company that develops and manufactures a range of human therapeutics.

A $116 billion behemoth, Amgen is one of the world’s foremost healthcare institutions and an absolute juggernaut in the biotechnology space.

They provide the world with a variety of necessary treatments for various health issues.

And with a global population that’s growing older, larger, and richer, demand for and access to quality healthcare drugs will only surely grow in time.

With blockbuster branded drugs like Enbrel, Neulasta, Prolia, Sensipar, and Epogen, Amgen should continue to handsomely profit from that long-term trend.

That simple idea is what’s turned Amgen into the massive company it is today – and it’s been one of the best-performing stocks over the last 20 years.

While they continue to rake in the profit from their numerous treatments across oncology and immunology, they also commit themselves to maintaining a strong pipeline of drugs (32 compounds across all three phases) that should allow the company to increase its profit (and thus its dividend) for many years to come.

Speaking of the dividend, it’s relatively large, sustainable, and growing.

Amgen has increased its dividend for the past eight consecutive years.

Not the longest streak around to be sure, but it’s a fantastic track record of the biotech space.

Plus, consider the five-year dividend growth rate is sitting at a monstrous 26.1% – even the most recent dividend increase was over 15%.

There’s plenty of evidence that indicates the company is in a great position to build on that, and they could very well eventually amass a multi-decade run of dividend growth.

Part of that evidence is the payout ratio – sitting at just 44.7% (using adjusted TTM EPS).

But it’s not just growth and sustainability, as the stock offers a relatively appealing yield right now.

Coming in at a yield of 2.93%, that’s well above the broader market.

It’s also three times higher than the industry average.

And it’s also more than 80 basis points higher than the stock’s five-year average yield.

There’s a lot to like about the dividend here, but the future sustainability and growth of that dividend will largely hinge on the underlying profit growth the business is able to deliver.

In order to estimate that future profit growth, which will help us gauge future dividend growth and in turn estimate intrinsic value, we’ll look at what the company has already done over the last decade. And we’ll compare that to a professional near-term forecast for future EPS growth.

Blending the known past and estimated future in this manner should allow us to draw some reasonable conclusions about the business.

Amgen has increased its revenue from $15.003 billion to $22.849 billion between fiscal years 2008 and 2017. That’s a compound annual growth rate of 4.78%.

This is right about what I’d expect from a fairly mature business like this. Mid-single-digit top-line growth is right in line with any rational expectation.

Meanwhile, the company expanded its earnings per share from $3.77 to $12.58 (adjusted for FY 2017) over this same period, which is a CAGR of 14.33%.

That’s nothing short of spectacular.

To be fair, I used the adjusted EPS figure for FY 2017, as the company took a massive one-time charge related to the passage of tax reform (which hits their repatriated cash and equivalents).

Still, you could have backed things up by one fiscal year on either side and come out with a very similar number.

What happened is, the company systematically improved its margins while simultaneously buying back heaps of its own stock.

Net margin has moved from incredible to… more incredible.

And the outstanding share count has been reduced by over 30%.

Moving out over the next three years, CFRA believes Amgen will compound its EPS at an annual rate of 6% over the next three years. CFRA cites headwinds from slowing growth in legacy drugs that will offset growth from new products.

This would be a marked drop from what’s transpired over the last decade.

And with the repatriated cash acting as “ammo” for the company as it relates to buybacks, M&A, it seems to be an awfully pessimistic take on growth.

Nonetheless, the modest payout ratio, obvious commitment to the dividend, and the aforementioned cash pile all add up to very strong dividend growth potential over the near term and long term.

Even just 6% annual bottom-line growth would still allow for 10%+ annual dividend growth for the foreseeable future.

Looking at the balance sheet, the leverage is acceptable, especially considering the cash they have on hand.

The long-term debt/equity ratio is 1.35, while the interest coverage ratio is over 8.

Solid numbers, although not massively impressive.

What’s interesting here, though, is the fact that cash alone can cover all of the long-term debt, making the balance sheet appear to be superb at first glance.

For reference, Amgen has over $40 billion in total cash.

The issue with that line of thought, however, is that it’s more likely the company will use that cash in other ways.

Profitability is, as foreshadowed earlier, nothing short of marvelous.

Over the last five years, the firm has averaged annual net margin of 25.44% and annual return on equity of 21.17%.

These numbers should pop off the page. And that’s even with including FY 2017’s aberration. Otherwise, they’d both be even higher – and more incredible.

There’s almost nothing to like about the fundamentals here. It’s a business that’s being run about as well as possible.

Strong growth, extremely robust profitability, a massive cash pile, a rock-solid dividend, and a lineup of some of the biggest and best drugs on the planet. It doesn’t get much better than that.

However, patent cliffs are always something you have to be concerned about with any pharmaceutical company.

And then there’s the regulation, litigation, and competition risks that are omnipresent in this industry.

But there’s nothing to indicate that Amgen will do anything other than increase its dividend at a very attractive rate for many years to come – which bodes well for dividend growth investors in it for the long haul.

Obviously, it’s a great dividend growth stock. But even great dividend growth stocks can make for relatively poor investments, especially over the short term, if the price paid is too high.

Fortunately, this stock looks undervalued right now…

The P/E ratio (using adjusted TTM EPS) is sitting at 14.62, which is significantly lower than the broader market.

That also compares very favorably to the stock’s own five-year average P/E ratio of 18.5.

There’s also the fact that investors are paying more than 10% less for the company’s cash flow in comparison to the three-year average.

And the yield, as discussed earlier, is substantially higher than its own recent historical average.

So the stock does look quite cheap, but how cheap might it be? What would a sensible estimate of intrinsic value look like? 

I valued shares using a dividend discount model analysis.

I factored in a 10% discount rate and a long-term dividend growth rate of 7.5%.

That DGR is awfully conservative when you line it up against both the 10-year demonstrated dividend growth and the most recent increase. And that’s almost half the company’s 10-year compound annual growth rate in EPS.

But I’m also considering the forecast for slowing near-term EPS growth and a payout ratio that is higher today than it was just five years ago.

The DDM analysis gives me a fair value of $227.04.

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.

My perspective shows a stock that is quite possibly undervalued by a large amount.

But I think it adds value and depth to check my valuation against what select professional analysts have come up with. This gives you readers multiple angles to compare.

And averaging these different viewpoints out should give us a very fair-minded valuation to conclude with.

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 AMGN as a 4-star stock, with a fair value estimate of $198.00.

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 AMGN as a 3-star “HOLD”, with a 12-month target price of $200.00.

So I came out slightly strong here, but averaging the three numbers out gives us a final valuation of $208.35. That would indicate the stock is potentially 16% undervalued here.

Bottom line: Amgen, Inc. (AMGN) is a high-quality biotechnology firm that is one of the world leaders in its field. Demands for its products should only increase over the long run, setting a foundation for more profit and dividends. Amazing fundamentals, a massive cash hoard, demonstrated double-digit long-term dividend growth, and the possibility that shares are 16% undervalued means this is a stock that could cure your portfolio of any ills.

— Jason Fieber

Note from DTA: How safe is AMGN’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 90. 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, AMGN’s dividend appears very safe and extremely unlikely to be cut. Learn more about Dividend Safety Scores here.

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