Many challenges in life seem difficult at first glance.

Getting in great shape. Learning a new skill. Building a relationship.

Becoming wealthy.

But these challenges are actually not all that complex once you break them down.

However, you do have to one thing.

You have to stay consistent.

If there’s anything life’s taught me, it’s that consistency separates the best from the rest.

Any time you see a successful person, you should know they’re consistently applying best practices toward whatever it is they’re successful at.

Take, for example, my situation.

I’m financially independent. I quit my job and retired in my early 30s. I now live abroad, in Thailand, living out my early retirement dreams.

How did this happen? 

Well, you can read about much of it in my Early Retirement Blueprint.

I’ll spare you some suspense, however.

I consistently saved my money and invested that capital into some of the best businesses in the world. 

I lived well below my means.

And I invested my savings into dividend growth stocks like those you’ll find on the Dividend Champions, Contenders, and Challengers list.

Month in and month out. Rain or shine. Ups and downs. I was consistently giving the journey to FIRE all of my effort and focus.

And now I control the FIRE Fund, which is my real-life and real-money stock portfolio.

This collection of high-quality dividend growth stocks generates the five-figure and growing passive dividend income I need to cover my essential expenses in life.

Jason Fieber's Dividend Growth PortfolioOnce you’re consistently saving, you need great investment ideas so that you can put your capital to work.

And that’s what today’s article is all about.

I’m going to share with you a high-quality dividend growth stock that appears undervalued right now.

Price is what something costs, but value is what something is worth.

Stocks, as with anything else in life, will treat you and your capital better when you can get great deals on them.

Routinely overpaying for anything in life is a bad idea, but it’s especially troublesome when talking about your investments.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and reduced risk. 

This is 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.

A higher yield means more investment income on your invested dollar.

It also means greater long-term total return potential.

That’s because total return is comprised of investment income (through dividends or distributions) and capital gain. Giving the former a boost right out of the gate bodes well.

But capital gain is also given a possible boost via the “upside” that exists between price and value.

While the market isn’t necessarily great at accurately pricing stocks in the short term, pricing does tend to correlate fairly well with value (which itself tracks profit) over the long term.

And that “upside” is on top of whatever organic capital gain would manifest itself as a company increases its profit and becomes worth more.

Of course, this should reduce risk.

It’s naturally less risky to pay less, versus more, for the same exact asset.

You’re risking less capital.

In addition, you create a margin of safety, which protects your downside from unforeseen issues (mismanagement, new regulations, etc.).

These advantages should be pursued with every investment.

Fortunately, fellow contributor Dave Van Knapp has made undervaluation a lot easier to spot and pursue.

Lesson 11: Undervaluation is part of an overarching series of “lessons” on dividend growth investing that Dave put together.

It focuses specifically on valuation, and it’s very much worth reading.

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…

BlackRock, Inc. (BLK)

BlackRock, Inc. (BLK) is a global investment management corporation based in the US. They’re the largest asset manager in the world, with ~$6.4 trillion in assets under management.

Becoming an investor has never been easier than it is today. Almost everyone has an opportunity to invest in global growth and take advantage of compounding’s magic.

Accessibility is a huge part of why that is.

And BlackRock is a huge part of that accessibility.

Through their various platforms, they allow everyone from regular workers all the way up to institutional clients to invest in both active and passive financial products.

It’s the latter that has proved particularly popular in recent years, as clients are no longer interested in paying sky-high fees on invested capital.

There’s a clear trend in investing: investors want low-cost, passive funds.

Indeed, the vast majority of BlackRock’s AUM are already in passive funds.

While this paradigm shift serves as a headwind for many asset managers out there, this bodes well for BlackRock. They’re the largest provider of exchange-traded funds (EFTs) in the world.

So they benefit from both the inflows and the fees generated on the passive funds, as well as the fact that the funds that are being bought are often BlackRock products (such as iShares).

They provide both the products and the services.

The stock market’s ascent over the last decade has no doubt inflated BlackRock’s AUM, but net inflows actually remain strong. 2017 saw a record $367 billion of full year total net inflows.

Meanwhile, even investors who buy individual stocks (like you and I) can buy BlackRock’s stock and still participate in the large transition to passive investing (due to the way BlackRock earns its profits). It’s a win-win.

Speaking of a win-win, BlackRock’s dividend is a huge win.

They’ve increased their dividend for nine consecutive years.

The 10-year dividend growth rate, at 14.1%, is nothing short of impressive.

There has been a slight dividend growth deceleration, though. The most recent dividend increase, for instance, was under 9%.

But with a payout ratio of 46.3% (using adjusted TTM EPS), the company is no doubt in an excellent position to continue raising the dividend at a fairly aggressive rate for the foreseeable future.

However, it’s not just growth here. There’s also income to be had.

The stock offers an appealing current yield of 3.18%.

That yield, by the way, is almost 100 basis points higher than the stock’s five-year average yield.

Being able to buy a stock with a 3%+ starting yield, while also looking at dividend growth at or near the double digits, sets you up very nicely for the long term.

Of course, estimating that future dividend growth is imperative to the investment story. We invest in where a company is going, not where it’s been.

That dividend growth estimation will also help us with valuing the stock.

In order to build that estimation, we’ll look at where this company has been over the last decade. That long-term track record gives us something to build upon.

And we’ll compare that to a near-term professional forecast for growth. Combining the known past and approximated near future should give us plenty to work with.

BlackRock grew its revenue from $5.064 billion in fiscal year 2008 to $12.491 billion in FY 2017. That’s a compound annual growth rate of 10.55%.

This is really incredible top-line growth, especially considering that this was a rather large starting base for an asset manager.

The performance of the stock market (which impacts AUM) over this period was a huge benefit, however. So that should be kept in mind moving forward. The US stock market in particular is elevated.

Their bottom-line growth was even more spectacular over this period, increasing from $5.78 to $22.60. That’s a CAGR of 16.36%.

I used adjusted EPS for FY 2017 in order to factor out the one-time tax benefit that isn’t material to earnings power.

An improvement in profitability, which was extremely robust to start, accounts for this excess bottom-line growth.

Looking forward, CFRA predicts that BlackRock will compound its EPS at an annual rate of 14% over the next three years.

This would be slightly off of what’s transpired over the last 10 years. But it would still be fantastic, if it comes to pass. It would certainly be more than enough to provide for big dividend raises. The moderate payout ratio sets a floor for this expectation.

CFRA cites share buybacks, widening margins, continuing net inflows, strong fund performance, and the small but growing Aladdin platform (a risk management tool for clients) as catalysts for its 14% CAGR projection.

Again, BlackRock could fall well short of this and still prove to be a great long-term investment.

Even 10% growth would be more than satisfactory. And that could set investors up for like dividend growth.

The glaring risk right now, however, is the state of elevated equity markets, especially in the US.

Moving over to the balance sheet, BlackRock’s business quality shines through once more.

The long-term debt/equity ratio is 0.16. Their interest coverage ratio sits at over 26.

It’s a rock-solid balance sheet.

Profitability is extremely robust.

Over the last five years, the firm has averaged annual net margin of 31.22% and annual return on equity of 12.57%.

There’s been a clear uptrend for profitability over the last decade, although the most recent FY was positively and artificially impacted by one-time tax benefits.

BlackRock is running an incredible business here.

The fundamentals across the board are fantastic. Take your pick. Growth. Profitability. Balance sheet. It’s all there.

Their competitive advantages lie in the scale of their operations and the switching costs inherent in the industry.

Assets tend to be quite sticky once they’re in place. BlackRock’s vast size thus means there are a lot of sticky assets sitting there.

The company’s diversification and ability to provide both products and services should insulate them from significant outflows, although a more volatile stock market could mean more volatile AUM.

I see the biggest risk being related to the elevated US stock market. Rising rates could pressure equities.

In addition, the company’s size could work against them. They will need to register large inflows regularly in order to continue growing.

At the right valuation, though, this could be a phenomenal long-term dividend growth stock.

Well, the valuation appears to be compelling here…

The stock is trading hands for a P/E ratio of 14.57 (using adjusted TTM EPS).

That’s well below the broader market, for what’s arguably an above-market business. That also compares favorably to the stock’s own five-year average P/E ratio of 18.7.

Most other basic valuation metrics are below their respective recent historical averages.

And the yield, as noted earlier, is significantly higher than its own five-year average.

So the stock does look cheap. But how cheap might it be? What would a reasonable estimation 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%.

That DGR is in the middle of the range I ordinarily allow for.

The moderate payout ratio, underlying growth, and forecast for future growth all more than support that number.

Moreover, it’s well below the demonstrated long-term DGR.

I believe they’ll come in much higher than this over the long run, but I do like to err on the side of caution. This is, in my view, a rather cautious look at the stock’s valuation due to the US stock market.

The DDM analysis gives me a fair value of $446.55.

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.

Even a conservative model came up with a valuation that’s above where the stock is trading at.

This speaks volumes.

But we’ll now compare that valuation with where two professional stock analysis firms have come out at.

This adds balance, depth, and perspective to our conclusion.

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 BLK as a 4-star stock, with a fair value estimate of $500.00.

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 BLK as a 4-star “BUY”, with a 12-month target price of $485.00.

I came out with the lowest number. Not a surprise. I was being cautious. Averaging out these three numbers gives us a final valuation of $477.18. That would indicate the stock is potentially 21% undervalued here.

Bottom line: BlackRock, Inc. (BLK) is the world’s largest asset manager. They have unrivaled scale, a rock-solid balance sheet, phenomenal profitability, and plenty of growth to go around. With a ~3% yield, double-digit long-term dividend growth, a very safe payout ratio, and the possibility that shares are 21% undervalued, this should be a strong candidate for any dividend growth investor’s portfolio.

-Jason Fieber

Note from DTA: How safe is BLK’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 97. 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, BLK’s dividend appears very safe with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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