This Dividend Growth Stock Appears 18% Undervalued

Welcome back to the Valuation Zone, and our first well-valued dividend growth stock for 2019.

This month we go into the Finance sector and the Capital Markets industry. The company is BlackRock (BLK), which bills itself as the leading global investment/asset manager.

BlackRock serves many of the world’s largest companies, pension funds, foundations, and public institutions, as well as millions of individual investors. It may be best known among individuals for its iShares collection of ETFs (exchange-traded funds). There are more than 800 of them.

Quality Snapshot and Dividend Safety

Here is BlackRock’s Quality Snapshot. To create this, I use:

  • Safety and Financial Strength grades from Value Line
  • S&P’s credit rating
  • Morningstar’s moat rating, and
  • Simply Safe Dividends’ dividend safety grade.

As you can see, BlackRock is a very high-quality company. It is one notch down from the top rating level on the first two metrics, and in or near the top level on all the others.

BlackRock currently yields 3.2%.

It has raised its dividend for 9 straight years.

That’s not very long, and it doesn’t span a recession.

(The company held its dividend flat in 2009.)

On the other hand, BlackRock has existed as a public company only since 1999, and it has paid a dividend for 15 straight years, which does span the Great Recession.

Simply Safe Dividends considers BlackRock’s dividend to be very safe and unlikely to be cut.

Dividend growth has been fast over the past few years:

BlackRock’s Valuation

To value a stock, I use four different methods, then average them out. For more details, see Dividend Growth Investing Lesson 11: Valuation.

 Step 1: FASTGraphs Default Valuation

In the the first step, we check the stock’s current price against FASTGraphs’ basic estimate of its fair value.

FASTGraphs compares the stock’s current price-to-earnings (P/E) ratio to the historical average P/E ratio of the whole stock market. That historical average is 15.

The fair value reference line is shown in orange line on the following graph, while the black line is BlackRock’s actual price. I’ve circled the stock’s actual current P/E ratio.

Under this method, BlackRock is slightly undervalued, because its actual price is just below the orange reference line. You can see that its price declined pretty much throughout all of 2018.

Here’s how to calculate the degree of undervaluation: Make a ratio out of the two P/Es.

Formula for Measuring Valuation on FASTGraphs

Actual P/E divided by Reference P/E

14.2 / 15  = 0.95

That translates to BlackRock being 5% undervalued. I consider anything within +/- 10% to be “fairly valued,” because valuation assessment are estimates, not physical traits.

Using that valuation ratio, you can calculate BlackRock’s fair price: Divide its actual price by the valuation ratio:

Formula for Calculating Fair Price

Actual Price divided by Valuation Ratio

$392 / 0.95 = $413

I round prices off to the nearest dollar so as not to create a false sense of precision.

Step 2: FASTGraphs Normalized Valuation

In this step, we “normalize” the comparison to make it specific to the stock’s own long-term valuation rather than to the market as a whole.

We do this by comparing BlackRock’s current valuation to its own historical valuation. I use the 5-year average P/E ratio (circled) for this step. (I used the 7-year historical chart to get the 5-year average P/E, because the final 2 years are projections that don’t count in the calculation.)

This 2nd step changes the picture. BlackRock’s 5-year average P/E ratio of 18.7 is quite a bit higher than the 15 that was used in the first step.  You can see that the stock was significantly overvalued in early 2018, before it began its price decline.

Valuation ratio: 14.2 / 18.7 = 0.76, or 24% undervalued

Fair price: $392 / 0.76 = $516

Step 3: Morningstar Star Rating

The next step is to see how Morningstar values the stock.

Morningstar takes a different approach to valuation. They ignore P/E and other conventional valuation ratios.

Instead, they use a discounted cash flow (DCF) model. Using conservative estimates for future projections, they discount all of the stock’s estimated future cash flows back to the present to arrive at a fair value estimate. (If you would like to learn more about how DCF works, check out this excellent explanation at moneychimp.)

Here is Morningstar’s conclusion:

On Morningstar’s 5-star system, 4 stars means that they think BlackRock is undervalued. Specifically, they see it selling at a 22% discount to fair value, which they calculate at $500 per share.

Step 4: Current Yield vs. Historical Yield

The 4th and final valuation method is to compare the stock’s current yield to its historical yield.

If a stock is yielding more than its historical average, that suggests that it is a better value than usual, because you are “paying less” for the stock’s dividends. You can buy more shares with the same amount of money. Because dividends are paid per share, you will get more dividends for your purchase money.

[Source: Simply  Safe Dividends]

BlackRock’s current yield of 3.2% is 28% above its average 5-year yield of 2.5%.

To calculate the degree of discount, we again form a ratio, this time of the yields:

Formula for Measuring Valuation by Comparing Yields

Historical Yield divided by Current Yield

2.5% / 3.2% = 0.78

That would suggest 22% undervaluation. When I use this yield comparison, I cut off the ratio at 20%, because this is the least direct way to estimate stock valuations, and I want to be conservative.

Using 0.80 as our valuation ratio, we get a fair price of $392 / 0.80 = $490.

BlackRock’s Valuation Summary

Now we average the 4 approaches.

The average of the 4 fair-price estimates is $480, compared to BlackRock’s actual price of about $392. That’s an 18% discount to fair value, suggesting that there is quite a bit of a margin of safety for someone buying the stock now.

I see the fair price as $480 per share.

Closing Thoughts

BlackRock is selling for an attractive price right now. It is a high-quality business with a nice yield (3.2%) and a solid (if short) dividend growth record.

That said, it’s in the asset-management industry of the finance sector, which can be notoriously fickle.

Here’s what Morningstar has to say in its Bulls / Bears feature (AUM means assets under management):

For further insight, two of my Daily Trade Alert colleagues have analyzed BlackRock within the past 3 months:

  • Mike Nadel purchased the stock for his Income Builder Portfolio in November (see article).
  • Jason Fieber made BlackRock his Undervalued Dividend Stock of the Week early in December (see article). He came up with a fair value of $477 at that time.

This is not a recommendation to buy BlackRock. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future, as well as its effect on your portfolio’s diversification. And be sure to consider whether it fits (or does not fit) your long-term investing goals.

— Dave Van Knapp

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