Some investors, especially newer investors, believe that it’s imperative to jump on trends before they blow up.
It’s as if you can only make good money as an investor if you’re able to scope out some kind of major disruption a mile before everyone else.
Well, that’s just not true.
You can invest in major, global, life-changing trends long after they have a chance to mature.
In fact, this is arguably the far more prudent way to go about it, as it gives you a chance to learn as much as you can about changing dynamics while also letting the long-term winners separate themselves from the rest of the pack.
For example, Warren Buffett has been buying up stock hand over fist in Apple Inc. (AAPL) lately – more than a decade after the iPhone was first announced.
Buffett didn’t spot this trend before anyone else, but he was patient enough to allow Apple to mature into a high-margin cash machine.
And the investment in Apple is now the single largest position in the common stock portfolio for Berkshire Hathaway Inc. (BRK.B).
This patience, allowing trends and winners to play out a little bit, also allows one to eventually pick out the highest-quality businesses that can afford to pay out a growing dividend.
That’s key for dividend growth investors like myself.
Investing in high-quality dividend growth stocks for the long term has allowed me to become financially free and retired early at 33 years old – a good three decades before most people are thinking about retiring from their jobs.
I was once broke, unhappy, and overworked at a job I didn’t like.
But I set a plan in motion that I thought could allow me to retire very early in life.
That plan is essentially my Early Retirement Blueprint, which is a step-by-step guide that almost anyone can follow to their early retirement dreams.
But a major aspect of that plan is dividend growth investing.
This long-term investment strategy involves buying up stock in world-class businesses that are so effective at routinely registering higher profit year in and year out, they return a good chunk of that cash directly to their shareholders, via growing cash dividend payments.
It’s a bonanza for long-term investors.
You accomplish not only investing in great businesses (which is the only way to go as a long-term investor), but you also end up building a sustainable source of growing passive income.
If you have designs on retiring early, it’s very important that you develop that passive income. If you’re ever going to quit your job, you need a source of regular income to pay your bills. And it’s obviously far better if that passive income is growing, for your bills will surely increase over time (which is a function of inflation).
My real-life and real-money dividend growth stock portfolio is my FIRE Fund.
It generates the five-figure and growing passive dividend income I need to cover my basic bills in life.
Many stocks in my personal portfolio can also be found on the Dividend Champions, Contenders, and Challengers list, which is an invaluable source of information on almost 900 US-listed stocks that have raised their dividends each year for at least the last five consecutive years.
Of course, there’s more to dividend growth investing than just buying dividend growth stocks and holding them.
You have to perform your due diligence, which includes fundamental analysis, weighing out competitive advantages, assessing risk, and going through the process of valuing a stock against its price.
It’s that last part – valuation – that’s especially important.
Price is what you pay, but value is what you end up getting for your money.
And when the latter is well below the former, great things can happen.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and less risk.
That’s all relative to what the same stock might otherwise provide 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.
That higher yield goes on to positively affect investment income, which is a part of total return.
So that’s greater long-term total return potential right off the bat.
But total return is also comprised of capital gain.
And the “upside” that exists between price and value (when undervaluation is present) could result in additional capital gain, which is on top of whatever organic capital gain that would manifest as a business becomes worth more over time (as it increases its profit).
Total return is thus given a possible boost on both sides of the coin.
This, of course, has a way of reducing risk, too.
It’s obviously less risky to pay less money for the same exact asset. And one would rather outlay less capital on the same stock.
This builds in a margin of safety, which offers some protection to the investor against losses (ending up with an investment that’s worth less than what was paid) in case some element of the initial investment thesis is incorrect.
Fortunately, these favorable dynamics aren’t terribly difficult to spot.
Fellow contributor Dave Van Knapp has made that process much easier via a process that is designed to value dividend growth stocks, eliminating a lot of the guesswork.
That process is Lesson 11: Valuation, which is part of an overarching series of articles that serve to educate novice and experienced investors on the entirety of the dividend growth investing strategy.
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…
Albemarle Corp. (ALB)
Albemarle Corp. (ALB) is a global specialty chemicals company that has leading positions in lithium, bromine, and refining catalysts.
They operate across the following three business segments: Lithium & Advanced Materials, 43% of FY 2017 revenue; Bromine Specialties, 28%; and Refining Solutions, 25%. Corporate and All Other account for the remaining 4%.
So I spoke earlier about not needing to jump on trends right away.
Well, one of the biggest trends out there is the move toward cleaner energy, which is affecting everything from the way homes and businesses think about and consume energy to the type of cars people are buying.
The very fabric of society is changing, for our modern-day society requires regular and reliable access to energy.
Whereas global energy has long been heavily reliant on hydrocarbon resources, this is shifting toward cleaner energy sources like wind, water, and solar.
And a key component to this shift is the storage of energy.
Well, that’s where lithium in particular comes into play. Most of the storage solutions that we now have (like batteries) require lithium. And large batteries (like those in cars) require a lot of it.
Massive producers of lithium, operating at scale, are integral to this major trend.
And as the #1 lithium producer, Albemarle is positioned perfectly to take advantage of this shift.
Well, dividend growth investors can take advantage, too, as Albemarle has the proven operations and dividend growth to make it an easy investment.
This trend, and this company specifically, has perhaps matured to a level where it might make sense to finally jump in, especially knowing that the runway for growth still appears incredibly long.
That should, in turn, lead to a lot of dividend growth.
As it sits, Albemarle has increased its dividend for 24 consecutive years.
Now, much of that history is based purely on their legacy chemical operations. It’s only relatively recently that Albemarle has aggressively moved into lithium, after closing on their 2015 acquisition of Rockwood Holdings, Inc.
It should be fairly clear that the strong move into lithium took what was already a strong company in chemicals and made it into something far more formidable.
This should bode well for the dividend moving forward.
The 10-year dividend growth rate stands at 11.7%, although recent dividend increases have been a bit more tame as Albemarle has swallowed their acquisition and adjusted their business.
And with a yield of 1.40%, there’s certainly something to be desired in terms of current investment income.
But patient, long-term dividend growth investors should be rewarded with plenty of aggregate dividend income (and capital gain) over the long run.
The payout ratio is 21.2% (based on TTM EPS that factors out the tax hit to Q4 FY 2017).
So there’s obviously plenty of room for more dividend growth moving forward, especially as Albemarle moves past their acquisition and lithium production/consumption continues to ramp up.
But in order to really be able to gauge where the company might go moving forward, which includes that dividend and the growth of it, we must look at the totality of the company – where it’s been, where it’s at, and what we think it will do over the near term.
So we’ll first look at the company’s top-line and bottom-line growth over the last decade, before comparing that to a near-term professional forecast of EPS growth over the next three years.
Blending the known past and estimated future like this should gives us a pretty good idea as to what kind of growth the company is capable of, which should more or less translate to the dividend growth. And this will greatly aid us when it comes time to value the business.
The company has increased its revenue from $2.467 billion in FY 2008 to $3.072 billion in FY 2017. That’s a compound annual growth rate of 2.47%.
Not a fantastic number, but the last few years have been a bit lumpy.
There was a big jump in revenue in FY 2015 after the Rockwood acquisition closed. But then FY 2016 revenue took a dip after Albemarle divested its Chemetall Surface Treatment business for $3.2 billion. The latter move really cleaned up the balance sheet, even if revenue was impacted.
Meanwhile, earnings per share advanced from $2.09 to $4.59 over this period, which is a CAGR of 9.13%.
A very strong result here, although I did used adjusted EPS for FY 2017 because the company took a massive hit from the passage of the 2017 Tax Cuts and Jobs Act.
Looking out over the next three years, CFRA is predicting that Albemarle will compound its EPS at an annual rate of 14%.
Much of that forecast is based on increasing battery demand, which portends powerful lithium growth. For reference, the company’s lithium business generated 56% adjusted YOY EBITDA growth in 2017.
If this 14% CAGR were to materialize, it would be a strong acceleration off of what the company has done over the last decade.
However, even something closer to that historical bottom-line growth (~10%) would easily allow for double-digit dividend growth for years to come, as a slowly expanding payout ratio wouldn’t be an issue for this business.
Either way, the company is set up pretty well to deliver big dividend raises for as far as the eye can see.
The balance sheet, as hinted at earlier, has been cleaned up after the Chemetall transaction. Albemarle had some debt to deal with after the Rockwood acquisition, but we can see that they’ve committed themselves to lithium moving forward.
The long-term debt/equity ratio is 0.39, while total cash is actually almost as much as long-term debt.
While the interest coverage ratio looks low, at 4.88, that’s due to the impacts to FY 2017 numbers. On a trailing basis, it’s almost three times that high.
Overall, the balance sheet is in great shape after being improved last year.
Profitability is robust, although (once more) the numbers are skewed by FY 2017.
Still, the company averaged annual net margin of 11.25% over the last five years, while return on equity averaged an annual 13.41% over that period.
There’s a lot to like here, especially if you’re a believer in the big lithium trend moving forward.
The legacy business has been a great performer for decades, but they’ve bolted on an incredible lithium business that instantly transformed the company into the premier player in that space.
Of course, there are risks to consider here – these are raw materials and chemicals we’re talking about, so there’s the cyclical nature of pricing when it comes to commodities. And any change in battery technology could severely change the demand and growth trajectory for lithium.
But the diversified nature of the company and the overall dynamics seem to point to a risk-reward scenario that’s pretty favorable.
And that becomes even more favorable if the valuation is appealing, which appears to be the case right now…
The P/E ratio is sitting at 15.13 (using adjusted TTM EPS to factor out the tax hit), which obviously compares well to the broader market. That’s also well below the stock’s own five-year average of 23.9 (albeit using a comparison that’s based on GAAP EPS).
If we want to move away from earnings, we can look at cash flow.
The P/CF ratio, at 18.3, is lower than its three-year average of 18.8.
The P/S ratio is actually elevated off its recent historical average, but it’s hard to look at that because of the aforementioned changes to revenue of late.
If this stock is undervalued, how cheap might it be? What would a rational look at intrinsic value look like?
I valued shares using a two-stage dividend discount model analysis due to the low yield and high potential growth.
I factored in a 10% discount rate, a 10-year dividend growth rate of 12%, and a long-term dividend growth rate of 8%.
That 10-year DGR is actually right in line with what Albemarle has already done over the last decade – and that was before they had this substantial lithium business.
With accelerating growth and a very low payout ratio, they’re set up pretty well to deliver much more moving forward.
If anything, this is a very conservative valuation, but I do like to err on the side of caution. Plus, there’s major exposure to commodity pricing.
The DDM analysis gives me a fair value of $101.46.
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 look at this stock indicates we have a high-quality business that’s only slightly undervalued. One could do a lot worse than pay a fair price for a great business, especially one that’s so obviously exposed to a major trend.
But let’s see how that valuation lines up against what two professional analysis firms have concluded.
This will add depth, balance, and perspective to our bottom line.
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 ALB as a 4-star stock, with a fair value estimate of $125.00.
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 ALB as a 5-star “STRONG BUY”, with a 12-month target price of $135.00.
I came out the lowest, which isn’t a surprise since I was pretty conservative. Averaging out these three numbers gives us a final valuation of $120.49, which would indicate the stock is potentially 26% undervalued here.
Bottom line: Albemarle Corp. (ALB) is a high-quality company that has clearly hitched its wagon to a global megatrend. And dividend growth investors can easily hitch their wagons, too, since this stock offers an easy way in, along with an extremely low payout ratio, double-digit dividend growth, and the possibility that shares are 26% undervalued. Investors should definitely consider energizing their portfolios with this stock.
-Jason Fieber
Note from DTA: How safe is ALB’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 96. 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, ALB’s dividend appears very safe and extremely unlikely to be cut. Learn more about Dividend Safety Scores here.
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