This Dividend Growth Stock Looks Significantly Undervalued Right Now

Background

Bristol-Myers Squibb (BMY) is a major pharmaceutical company headquartered in NYC. It celebrated its 130th anniversary in 2017.

BMY researches, discovers, develops, and markets proprietary drugs for various conditions, including cardiovascular, oncology, and immune disorders.

BMY also has healthcare products in areas such as diagnostics, infant formula, orthopedic implants, and health and beauty aids.

When completed, BMY’s pending acquisition of Celgene (CELG) will also make it a player in biotechnology. Shareholder approval has been secured, and the companies are awaiting final regulatory approval.

Quality Snapshot and Dividend Safety

Here is BMY’s Quality Snapshot. I derive this from the following sources, which I have come to trust and respect over the years:

BMY gets above-average and excellent grades across the board. On a 0-to-5 point scale for each metric in the snapshot, BMY would collect 22 out of 25 points. That suggests that BMY is a very high quality company.

Regarding dividends, BMY yields 3.6%.

The company has increased its dividend 10 straight years (the dividend was held steady in 2009), including a 2.5% hike earlier this year.

That small increase is in line with BMY’s long-run dividend growth record.

Its 5-year dividend growth rate entering this year (2014-2018) has been 2.7% per year.

That combination of yield and dividend growth puts BMY in the good-yield, slow-growth category of dividend growth stocks.

The dividend is reliable, safe, and grows at a slow but steady rate.

The following graphics from Simply Safe Dividends sum up BMY’s dividend credentials.

BMY’s Valuation

To value a stock, I use four different methods, then average them out. For more details on my approach, 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 represents a fair-price reference line, computed at a P/E ratio of 15. The black line is BMY’s actual price.

Since the black line is below the orange line, it suggests that that BMY is undervalued. The end of the black line reflects the company’s current P/E ratio, which is 11.3 (circled).

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

11.3 / 15  = 0.75

That valuation ratio suggests that BMY is 25% undervalued.

To calculate the company’s fair price, divide its actual price by the valuation ratio:

Formula for Calculating Fair Price

Actual Price divided by Valuation Ratio

$46 / 0.75 = $61

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. The fair-price reference line is in blue on this graph.

This method suggests that BMY is even more undervalued than the first step. That’s because BMY’s 5-year average P/E ratio (circled) is 25.5, which is much higher than the market’s historical average of 15 used in the first step.

The formulas for the valuation ratio and fair price are the same as in the first step. Applying them, we get:

Valuation ratio: 11.3 / 25.5 = 0.44, or 56% undervalued

Fair price: $46 / 0.44 = $105

Step 3: Morningstar Star Rating

The next step is to consult Morningstar’s valuation of the stock.

Morningstar ignores P/E and other valuation ratios.

Instead, they use a discounted cash flow (DCF) model. Using conservative 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 calculates a 29% undervaluation. Normally, a gap this wide would rate 5 stars, in my experience with Morningstar. At any rate, they agree that BMY is very undervalued.

Morningstar calculates a fair value of $65 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.

With a well-valued stock, 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 (2) its dividend has increased. Or both.

In BMY’s case, it’s mostly because its price has been sliding down, because we have seen that its dividend growth has not been very fast. The inverse relationship between yield and price is illustrated in this 5-year graph.

BMY’s dividend yield has gone up 21% while its price has declined 5%.

Thus, BMY’s current yield is quite a bit higher than its 5-year average.

[Source: Simply  Safe Dividends]

BMY’s current yield of 3.6% is 38% higher than its 5-year average yield of 2.6%. That suggests that the stock is undervalued.

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

Formula for Measuring Valuation by Comparing Yields

5-Year Average Yield divided by Current Yield

2.6% / 3.6% = 0.72

That would suggest 29% 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 results.

Using 0.80 as our valuation ratio, we get a fair price of $46 / 0.80 = $58.

BMY’s Valuation Summary

Now we average the 4 approaches.

All four methods agree that BMY is undervalued.

The average of the four methods suggests a fair price of $72, compared to BMY’s actual price of about $46.

Even if we toss out Method #2 as an outlier, we would get a fair price of $61, which would suggest that BMY is selling at a 25% discount to fair value. I would still call that “Significantly undervalued” and color it dark green.

Whichever way you look at it, BMY seems to be more than 20% undervalued.

Closing Thoughts

With its good yield, very good quality rankings, and significant 25%-36% undervaluation, I think that BMY is a very attractive dividend growth investment.

Assuming that BMY’s 3.6% yield is “enough” for you, its biggest drawback is its consistently slow dividend growth rate in the 2.5% to 3% range each year.

The only article discussing BMY within the past two years on Daily Trade Alert is These 3 Income Stocks Are Saving Lives (November, 2017), which was written when BMY’s yield was just 2.5%. Its yield is 44% higher today.

This is not a recommendation to buy Bristol-Myers Squibb. 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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