I’m Seriously Considering This Stock as a New Position in My Dividend Growth Portfolio

Dominion Energy (D) is one of the largest domestic utilities. Based in Richmond VA, Dominion is an integrated company. It owns and operates electric generation facilities; natural gas transmission pipelines and storage facilities; and electric transmission lines.

Ranked by market value, Dominion is the 7th-largest publicly traded utility company in the world, and the 3rd-largest in the USA. Its operations serve customers in 14 states. [Source]

With a 16-year streak of raising its dividend, a yield approaching 5%, and recent dividend increases in the 8-10% range per year, Dominion is also a popular holding for dividend growth investors.

But is it a quality company? Is it well valued?

Let’s find out.

Quality Snapshot and Dividend Safety

Here is Dominion’s Quality Snapshot. To create this, I use the following sources, which I have come to trust and respect over the years:

• Safety and Financial Strength grades from Value Line
S&P’s Credit rating
Morningstar’s Moat rating, and
Simply Safe Dividends’ Dividend Safety grade.

Dominion gets an average of 2nd-tier quality ratings. It has one mid-tier rating (its credit rating shown in yellow) and one top-tier rating (its moat rating shown in dark green).

Dominion currently yields 4.8%. Its 5-year dividend growth rate (2014-2018) was about 8% per year.

Earlier this year, it increased its dividend payout by 9.9%.

That combination of yield and dividend growth puts Dominion in the high-yield, fast growth category of dividend growth stocks.

A 5-year increase rate over 8% per year is quite fast for a stock yielding nearly 5%.

[Image source: Simply Safe Dividends]

Dominion has raised its dividend 15 straight years.

[Image source: Simply Safe Dividends]

Dominion’s Valuation

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

Step 1: FASTGraphs Default Valuation

In the the first step, I 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 orange line corresponds to the reference P/E ratio of 15. The black line is Dominion’s price. I circled D’s own P/E, which is 18.7 at that price.

Under this first method, Dominion is well overvalued. Here’s how to calculate the degree of overvaluation: Make a ratio out of the two P/Es.

Formula for Measuring Valuation on FASTGraphs
Actual P/E divided by Reference P/E
18.7 / 15 = 1.25

I call that that the valuation ratio, and it translates to Dominion being 25% overvalued.

To calculate D’s fair price, divide its actual price by that valuation ratio:

Formula for Calculating Fair Price
Actual Price divided by Valuation Ratio
$77 / 1.25 = $62

If that were our only valuation method, we’d reject the stock. But valuations are assessments, not physical traits, so we want several points of view. We’ll get more from the following steps.

Step 2: FASTGraphs Normalized Valuation

In this step, we “normalize” the fair-value reference line to reflect the stock’s own long-term valuation rather than the market as a whole.

I use the stock’s 5-year average P/E ratio (circled) for this step. It’s shown by the blue line below.

This method changes the picture, because Dominion’s price is below its fair price when that is calculated using the 5-year average P/E.

The formulas for the valuation ratio and fair price are the same as in the first step.

Valuation ratio: 18.7 / 20.5 = 0.91, or 9% undervalued
Fair price: $77 / 0.91 = $85

The stock appears to be 9% undervalued using this method. I consider anything +/- 10% to be fairly valued, so technically I’d call it “fairly valued” in this step, even though mathematically it’s selling at a 9% discount.

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 the P/E and other familiar valuation ratios.

Instead, they use a discounted cash flow (DCF) model. Using conservative 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:

Morningstar also calculates a 9% undervaluation. Note that they call this “undervalued,” probably because they consider the uncertainty of the valuation to be low, so they don’t require a 10% margin of error to be confident in their call.

Morningstar calculates a fair value of $84 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. That means that you can buy more shares with your money. Because dividends are paid per share, you will get more dividends for that money.

There are two ways a stock achieves a yield above its historical average. Either (1) its price has dropped or stayed flat, or (2) its dividend has increased. Or both.

In Dominion’s case, it’s both. Dominion has been raising its dividend steadily, and its market price hasn’t kept up. That is illustrated in this 5-year graph of price vs. dividends.

Dominion’s dividend payout has gone up 53% while its price has gone up only 7%. That has resulted in its current yield being quite a bit higher than its 5-year average.

[Source: Simply Safe Dividends]

Dominion’s current yield of 4.8% is 26% higher than its average 5-year yield of 3.8%. That suggests that the stock is undervalued.

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

Formula for Measuring Valuation by Comparing Yields
5-Year Average Yield divided by Current Yield
3.8% / 4.8% = 0.79

That would suggest 21% undervaluation. When I use this comparitive-yield method, I cut off the difference at 0.80, because this is an indirect method of measuring valuation, and I want to avoid extreme values.

Using 0.80 as our valuation ratio, we get a fair price of $77 / 0.80 = $96.

Dominion’s Valuation Summary

There is a wide disparity among the four methods. Their average suggests a fair price of $82, compared to Dominion’s actual price of about $77.

That means that Dominion is selling at a 6% discount to fair value, which I consider in the fair-price range.

Closing Thoughts

With its high yield, fast dividend growth rate, good quality rankings, and 6% undervaluation, I believe that Dominion is an attractive dividend growth investment. I am seriously considering it as a possible new position in my Dividend Growth Portfolio.

For further insight, please see these reports:

• My colleague Brian Bollinger reported favorably on Dominion in this February, 2019 article: This Stock Remains a Solid High-Yield Choice for Conservative Investors.
• Dominion was one of Mike Nadel’s first additions (in 2018) to the Income Builder Portfolio that he is building for Daily Trade Alert, and he put it on his 2019 watch list for possible additions this year.
• Dominion was my pick as the Dividend Growth Stock of the Month in August, 2018.

This is not a recommendation to buy Dominion Energy. 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 always be sure to consider how and whether any asset fits (or does not fit) your long-term investing goals.

— Dave Van Knapp

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