I want to ask you a simple question.
What if you could double your money every seven years?
I imagine that would probably be pretty interesting to you.
It should be interesting, since it could make you incredibly wealthy over time.
Well, it’s not just interesting; it’s actually a very realistic possibility.
The “Rule of 72” tells us this:
Years to double = 72/interest rate.
The broader stock market has historically returned 10% annually.
That means doubling your money every ~7 years.
But you might do even better than that by picking out wonderful businesses at appealing valuations.
This is where dividend growth investing comes in.
This strategy, by its very nature, practically limits an investor to only the best businesses out there.
It’s a strategy that I personally used to go from below $0 at 27 to financially free at 33.
I show you exactly how I did that in my Early Retirement Blueprint.
Dividend growth investing can be used to outperform the market, generate significant passive income, and retire early!
My FIRE Fund is the culmination of living below my means and investing in high-quality dividend growth stocks.
It’s my real-money early retirement stock portfolio that generates the five-figure passive dividend income I need to live off of.
You can find hundreds of dividend growth stocks by checking out the Dividend Champions, Contenders, and Challengers list.
But the key is that you approach it intelligently, investing in great businesses at appealing valuations.
Price is what a stock costs, but value is what a stock is worth.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
A lower price should, all else equal, result in a higher yield.
That’s because price and yield are inversely correlated.
And since total return is simply comprised of capital gain and investment income, more of the latter means greater long-term total return potential.
That’s before factoring in the possibility of additional capital gain, due to the “upside” between a lower price and higher value.
The stock market isn’t necessarily very good at accurately pricing stocks over the short term. But price and value tend to more closely correlate over the long haul.
These dynamics should also reduce risk.
That’s via the introduction of a margin of safety, which protects the investor’s downside.
Maximize upside, minimize downside. That’s the name of the game.
Any number of unforeseen issues can pop up in the business world.
You should seek to insulate yourself as much as possible against unfavorable developments that can permanently destroy capital.
This is obviously all favorable.
But you first have to know how to spot a good value before you can take advantage of it.
That’s why fellow contributor Dave Van Knapp put together Lesson 11: Valuation.
Part of an overarching series of “lessons” on DGI, it seeks to provide you a fantastic valuation template that you can apply over and over again.
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.
FY 2018 revenue breaks down geographically as follows: 77%, US; 23%, Rest Of World.
As one of the world’s largest biotech companies, Amgen, Inc. is poised to continue benefiting from a simple trend.
That trend is this: the world as we know it is growing bigger, older, and richer.
It’s a circular relationship.
A major reason why the world continues to grow older is because of quality healthcare.
And as more people grow older and wealthier, demand for and access to high-quality healthcare services and products will surely grow. It’s practically inevitable.
This company is positioned well, as they market five of the world’s best-selling biotechnology drugs.
Blockbuster branded drugs including Neulasta (used in chemotherapy) and Enbrel (used to treat various autoimmune diseases) have earned, and continue to earn, the company billions.
And while some of their best sellers face maturing sales as these franchises age, newer branded products like XGEVA, Prolia, and KYPROLIS saw their respective FY 2018 sales grow well into the double digits.
Also, Repatha (used for controlling cholesterol), a future blockbuster, saw FY 2018 sales up by 72% YOY.
Meanwhile, they have a healthy pipeline that a significant R&D budget (~17% of Q1 2019 product sales) supports: there are 32 compounds across all three phases of development.
In addition, they have a number of biosimilars that are either approved or being launched.
Dividend Growth, Growth Rate, Payout Ratio and Yield
This bodes well for Amgen, Inc. and its shareholders, as that means increasing profits and dividends.
As it sits, the company has increased its dividend for nine consecutive years.
That’s as long as the streak could possibly be, since the company didn’t start paying a dividend until 2011.
It’s not the lengthiest track record around, but they make up for some of that with an incredible five-year dividend growth rate of 22.9%.
That kind of growth won’t continue forever; however, the three-year dividend growth rate is still a stout 18.7%. The most recent increase was almost 10%.
And with a fairly moderate payout ratio of 46.2%, there’s room for more where that came from.
On top of that growth, you get a very appealing yield of 3.37%.
That yield, by the way, is more than 100 basis points higher than the stock’s five-year average yield of 2.32%.
The dividend metrics here are fantastic.
You get an appealing yield along with double-digit dividend growth, all backed by a low payout ratio.
Of course, we invest in where a company is going, not where it’s been.
Revenue and Earnings Growth
It’s the future growth that we care about. And it’s that future growth that will tell us something about what the stock might be worth.
In order to estimate that future trajectory, I’m going to show you what company has done over the last decade in terms of top-line and bottom-line growth.
Building on that historic result, I’ll then add a professional forecast for near-term profit growth.
Blending these numbers together should give us a great idea as to what the future earnings could look like, which will likely translate pretty well to dividend raises.
Amgen, Inc. increased its revenue from $14.642 billion in FY 2009 to $23.747 billion in FY 2018.
That’s a compound annual growth rate of 5.52%.
Solid sales growth here.
Earnings per share advanced from $4.51 to $12.62 over this period, which is a CAGR of 12.11%.
That’s highly impressive.
The excess bottom-line growth appears to mostly be due to share buybacks.
The company decreased its outstanding share count by a dramatic 35% over the last decade.
Looking forward, CFRA is predicting that Amgen, Inc. will compound its EPS at an annual rate of 6% over the next three years.
That’s a bit less than half of what the company has produced over the last 10 years.
This is undoubtedly a conservative estimate, but I think you could argue that it’s warranted in this climate.
Drug companies are coming under additional regulatory scrutiny, and there is a lot of talk about putting additional pressure on drug prices.
Much of this rhetoric is originating in the United States, which is where Amgen, Inc. is concentrated.
Offsetting these concerns are the healthy pipeline, strong sales growth in newer drugs, and buybacks.
Regarding those buybacks, the company repurchased $3 billion of stock in Q1 2019. Seeing as how the stock appears to potentially be undervalued (the thesis of this very article), I think that’s a good use of cash.
Still, even a 6% CAGR in EPS would allow for dividend growth approaching or eclipsing double digits.
That’s because the payout ratio is still quite low. A slight expansion of that wouldn’t be an issue, assuming that EPS doesn’t contract.
Moving over to the balance sheet, the company has an excellent financial position.
The long-term debt/equity ratio appears high, at 2.36.
However, it’s high because of low common equity (rather than high debt).
The interest coverage ratio, at over 7, is good.
But where the balance sheet really takes a turn for the better is the cash position.
Total cash is sitting at over $29 billion.
It almost offsets all long-term debt by itself. That’s significant.
Profitability is, putting it mildly, outstanding. And this is probably why these companies are getting some heat on the pricing front.
Over the last five years, the company averaged annual net margin of 27.07% and annual return on equity of 25.13%.
These are numbers that many companies, across many industries, would love to have.
However, it’s largely driven by the nature of the industry. I wouldn’t say the profitability is particularly excessive or noteworthy relative to competitors.
Overall, Amgen, Inc. runs a phenomenal business. The fundamentals across the board are excellent.
Plus, the dividend growth just started. I can easily see this company one day sporting a multi-decade track record of dividend raises.
However, it’s important to consider risks.
Competition, regulation, and litigation are ominpresent risks for every company, although I think the regulatory environment right now is arguably a bit more uncertain than usual.
There are risks that drugs in the pipeline won’t reach market.
One risk unique to drug companies is the dreaded “patent cliff”, whereby blockbuster drugs go off patent and lose sales to generics and other products that are available at much lower prices.
But I do think the long-term reward outweighs the long-term risk.
Stock Price Valuation
That relationship looks even more advantageous right now due to the low valuation…
The stock is trading hands for a P/E ratio of 13.74.
That’s well below the broader market. It’s almost half that of the stock’s own five-year average P/E ratio of 25.7.
The P/CF multiple is only 10.6, which compares favorably to the five-year average P/CF ratio of 14.5.
And the yield, as noted earlier, is substantially higher than its recent historical average.
So the stock does look cheap. But how cheap? What would a reasonable 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 clearly much lower than what the company has produced since it first initiated its dividend.
But I’m being cautious here.
It’s expected that growth will slow.
The regulatory framework seems to be shifting.
And the payout ratio is higher than it was a few years ago.
I think it’s highly unlikely the company will grow its dividend at a lower rate than this over the long run, but I’d rather err on the side of caution.
The DDM analysis gives me a fair value of $249.40.
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.
The stock, even with a cautious analysis, looks downright cheap here.
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 AMGN as a 4-star stock, with a fair value estimate of $205.00.
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 $195.00.
I came in high. I’m honestly a bit surprised by that. But averaging out the three numbers gives us a final valuation of $216.47. That would indicate the stock is possibly 26% undervalued.
Bottom line: Amgen, Inc. (AMGN) is a high-quality company that has positioned itself very well to take advantage of a number of major trends in healthcare. Excellent fundamentals, a 3%+ yield, a moderate payout ratio, almost a decade of dividend raises, double-digit long-term dividend growth, and the potential that shares are 26% undervalued are all reasons why dividend growth investors should take a strong look at this stock.
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 82. 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 with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.Silicon Valley Bank Collapse: Steps You Must Take To Protect Yourself [sponsor]
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