With the economy of the United States still in a form of partial shutdown, it’s important to remember something.

Not all businesses are being affected in the same way.

The economy isn’t one monolithic structure.

There are millions of individual businesses in the USA.

And a number of these businesses are still operating and doing quite well.

While some industries will undoubtedly be hit hard by the pandemic and shutdown, there are other businesses out there that have been deemed “essential” and allowed to continue operating.

They’re at least taking in some revenue.

And that positions the businesses that pay dividends to maintain that behavior through a temporary crisis.

This should be a relief for people who live off of dividends.

Count me in that camp.

Jason Fieber's Dividend Growth PortfolioI live off of the five-figure passive dividend income my investments provide me.

Those investments form my FIRE Fund.

I went from below broke at age 27 to financially free at 33, as I recount in my Early Retirement Blueprint.

I did so by living below my means and investing in stocks.

Not just any stocks, though.

High-quality dividend growth stocks. 

Stocks like those you can find on the Dividend Champions, Contenders, and Challengers list.

Many of these stocks have been paying growing dividends for decades.

That includes countless challenges like recessions, wars, and political upheaval.

I can now add a global pandemic to that list.

Intelligent investing is not just picking random stocks off of a list, however.

Fundamental analysis and valuation are always critical.

Valuation in particular can play a large role in the performance of an investment.

Price is only what you pay, But value is what you actually get.

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.

Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.

That higher yield correlates to greater long-term total return potential.

This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.

Prospective investment income is boosted by the higher yield.

But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.

And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.

These dynamics should reduce risk.

Undervaluation introduces a margin of safety.

This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.

It’s protection against the possible downside.

Getting a great deal on a high-quality company that’s still operating through this temporary crisis could lead to tremendous wealth and passive income over the coming decades.

Fortunately, discerning value isn’t as difficult as you might think.

Fellow contributor Dave Van Knapp penned Lesson 11: Valuation to aid investors with valuation.

Part of an overarching series on dividend growth investing, this lesson provides a valuation template that you can apply to just about any dividend growth stock out there.

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…

Genuine Parts Company (GPC)

Genuine Parts Company (GPC) is a major American wholesale distributor of automotive replacement parts, industrial supplies, and office products.

Founded in 1928 and headquartered in Atlanta, Georgia, Genuine Parts Company now employs over 50,000 people and has more than 3,100 operations across the world.

Their revenue breaks down across the following three segments: Automotive, 57% of FY 2019 sales; Industrial, 34%; and Business Products, 9%.

Approximately 74% of revenue comes from the United States.

Major brands include NAPA, Motion Industries, and S. P. Richards Co.

Genuine Parts Company will certainly not end up unscathed by the pandemic.

But they are still operating. They’re situated about as well as they can be.

Per a recent press release by the company:

“Each of our automotive, industrial and business products segments have been classified as “essential” businesses and our operations remain substantially open to serve our customers through this pandemic, with the exception of France and New Zealand due to preemptive government mandates.”

That’s comforting.

We can take additional comfort in knowing that they’ve faced numerous large-scale challenges over the last century.

Yet they’ve continued to pay a growing dividend straight through much of that time frame.

Dividend Growth, Growth Rate, Payout Ratio and Yield

In fact, Genuine Parts Company has increased its dividend for 64 consecutive years.

That’s one of the longest such streaks in existence. It’s the only streak this long in the US automotive industry.

And they’re not growing the dividend at some feeble rate just to keep appearances.

The 10-year dividend growth rate is 6.6%, which is very solid with such low inflationary pressure.

On top of that, the stock offers a mouth-watering yield of 4.35% right now.

That’s much higher than what the broader market offers.

It’s also 145 basis points higher than the stock’s own five-year average yield, relating back to what I noted earlier about valuation and yield.

The dividend is protected by a payout ratio of 55.5% of adjusted TTM EPS.

I’m using adjusted EPS in this case because Q4 2019 was majorly impacted by restructuring. That quarter is not reflective of the company’s true earnings power.

Admittedly, this payout ratio can, and most likely will, temporarily climb higher due to reduced earnings from the pandemic-related economic fallout.

That will almost surely affect the rate of dividend growth over the near term.

But this dividend is sacrosanct. And the continuance of it, even absent much growth for the next year or so, is about as assured as you’ll find in these times.

Revenue and Earnings Growth

Now, this is looking at what’s already transpired.

But investors ultimately put capital at risk for future results.

Thus, I’ll now build out a forward-looking trajectory appraisal for Genuine Parts Company, which will later help us estimate intrinsic value.

I’ll first rely on what the company has done over the last decade in terms of top-line and bottom-line growth, using 10 years as a reasonable proxy for the long term.

Then I’ll compare that to a near-term professional prognostication of profit growth.

Combining the proven past with a future forecast like this should allow us to draw some sensible conclusions regarding their future path.

Genuine Parts Company grew its revenue from $11.208 billion in FY 2010 to $19.392 billion in FY 2019.

That’s a compound annual growth rate of 6.28%.

Really strong.

I usually like to see a mid-single-digit top-line growth rate from a mature company.

They blew right past this, although it’s notable that there were a number of acquisitions and divestitures over the last decade that clouds results.

Meanwhile, earnings per share expanded from $3.00 to $5.69 (adjusted) over this period, which is a CAGR of 7.37%.

A pretty similar result to revenue growth, albeit slightly supercharged by some minor share repurchases.

We can now see that the dividend growth has been roughly in line with business growth, indicating prudence on the part of management.

Looking forward, CFRA believed Genuine Parts Company would compound its EPS at an annual rate of 3% over the next three years.

The forecast was provided on March 16. That’s after the pandemic’s effects became apparent.

This is more than a 50% haircut in anticipated growth, relative to what Genuine Parts Company has done over the last decade.

I think that’s fair, if conservative.

However, on May 6 (after Q1 FY 2020 results), they pulled that forecast and currently have no growth forecast at all.

The very near term could be really ugly. I have no doubt about that. It’s just so uncertain right now for all business.

However, when you start to think about where this company and the broader economy might be in 2022 or so, there’s very much to be optimistic about in terms of a return to normal and pent-up demand.

After all, the economy was excellent before the virus came on the scene.

I would absolutely temper expectations on dividend growth over the next year or so – perhaps even to the point of a flat dividend.

But this is one of the most secure dividends out there, and high-single-digit dividend growth could return within a relatively short period of time.

Financial Position

Moving over to the balance sheet, the company has long held a fortress balance sheet with few rivals.

That financial strength has taken a hit in recent years, most notably after the acquisition of London-based Alliance
Automotive Group for ~$2 billion in 2017.

This move gave Genuine Parts Company a major foothold in Europe – AAG was the second-largest parts
distributor in Europe. It did come at the expense of some balance sheet flexibility, though.

The long-term debt/equity ratio is 0.76, while the interest coverage ratio is just over 9.5.

We’re still looking at a rock-solid balance sheet. It’s just not as incredible as it once was.

Profitability is good, especially considering that the core of the business operates basically as a retailer.

Over the last five years, the company has averaged annual net margin of 4.08% and annual return on equity of 20.66%.

ROE is actually pretty impressive since they historically have not used a lot of debt.

There’s really a lot to like about Genuine Parts Company.

It’s a quality company that produces a number of necessary parts and supplies in a range of industries. These parts and supplies are so necessary that their businesses have been deemed “essential”, even in a time of a global pandemic. That speaks volumes.

Their well-regarded brands, economies of scale, and wide distribution network provide the company with durable competitive advantages.

Of course, there are risks to consider.

Competition, regulation, and litigation are omnipresent risks in every industry.

The company is exposed to recessions, although they’re somewhat protected from major drops in profit.

Any progress in self-driving cars is a threat, as more efficient driving patterns reduce miles driven and wear and tear.

The company’s largest issue right now is the partial shutdown and the mass reduction in driving, which further reduces wear and tear on vehicles and the need for replacement components. But I see this as a temporary issue rather than a large-scale threat to the business model.

With these risks known, I see Genuine Parts Company as a low-risk but high-quality company.

This is a stock I haven’t covered before in this series because it’s perpetually looked fairly valued, or even expensive at times.

It’s a premium company that’s often commanded (and deserved) a premium.

But the pandemic has brought even the highest-quality stocks down, and this stock looks attractively valued for the first time in years…

Stock Price Valuation

The stock is trading hands for a P/E ratio of 13.49.

That’s based on adjusted TTM EPS (factoring out the big Q4 FY 2019 hit).

This is obviously well below the broader market’s valuation.

It’s also materially lower than the stock’s own five-year average P/E ratio of 20.1.

If we strip away the adjustments and look at straight cash flow, we still see a valuation disconnect.

The P/CF ratio is currently at 11.9, which is way off of the stock’s three-year average P/CF ratio of 15.3.

And the stock’s yield, as I noted earlier, is significantly higher than its recent historical average.

So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?

I valued shares using a dividend discount model analysis.

I factored in a 9% discount rate (due to the elevated yield) and a long-term dividend growth rate of 5.5%.

This DGR is about 100 basis points lower than the long-term DGR that Genuine Parts Company has produced.

It’s almost 200 basis points lower than the company’s 10-year EPS CAGR.

I’m clearly being conservative here, but I think this environment warrants caution.

In my view, Genuine Parts Company’s dividend will likely grow much slower than the historical norm over the next year or so. But I also believe they’ll bounce back within the next few years.

This DDM analysis is not designed to have you expect 5.5% dividend raises uniformly from here on out. Rather, I think this is a reasonable long-term expectation, on average.

The DDM analysis gives me a fair value of $95.25.

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.

My analysis was not excessively aggressive, yet the stock still looks cheap.

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 GPC as a 4-star stock, with a fair value estimate of $90.00.

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 GPC as a 4-star “BUY”, with a 12-month target price of $90.00.

We have a pretty tight consensus here. Averaging the three numbers out gives us a final valuation of $91.75, which would indicate the stock is possibly 26% undervalued.

Bottom line: Genuine Parts Company (GPC) is a high-quality company with “essential” businesses in a very uncertain environment. With more than 60 consecutive years of dividend raises, a market-smashing 4%+ yield, a sacrosanct dividend, and the potential that shares are 26% undervalued, this might be your chance to finally buy this amazing dividend growth stock on sale.

— Jason Fieber

Note from DTA: How safe is GPC’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 72. 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, GPC’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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