Disruption is a constant in our society.

Businesses are facing change at all times.

This creates a big challenge for long-term investors.

If you want to invest safely for long periods of time, your portfolio should have “bedrock” stocks.

These are businesses that provide the world with products and/or services that are always necessary.

While we don’t know exactly what kind of technologies will be around in 20 years, we do know that human beings will always need things like food, water, medicine, and shelter.

This is a very common understanding that can lead to uncommon profit.

Indeed, I’ve built my FIRE Fund around a number of my own bedrock stocks.

The six-figure FIRE Fund is my real-money stock portfolio.

Jason Fieber's Dividend Growth PortfolioAnd it generates the five-figure passive dividend income I live off of.

I actually live off of that income at a very young age.

As I lay out in my Early Retirement Blueprint, I saved and invested my way to a retirement in my early 30s.

But it’s not just saving and invested.

It’s targeted, strategic saving and investing.

In regard to the investing portion, I’ve taken advantage of dividend growth investing.

This strategy advocates investing in world-class enterprises that pay reliable and rising cash dividends.

The Dividend Champions, Contenders, and Challengers list contains invaluable data on more than 700 US-listed stocks that have raised their dividends each year for at least the last five consecutive years.

It takes a special kind of business to regularly hand out increasing dividends to shareholders.

Building an entire portfolio of these special stocks can lead to special results over the long term.

But one can’t buy any dividend growth stock at any price.

Fundamental analysis is very important.

And valuation is critical.

Price is what you pay, but it’s value that you 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.

Buying a “bedrock” dividend growth stock that caters to basic human needs – and buying this stock when it’s undervalued – is an almost surefire path to huge wealth and passive income.

The good news is, valuation isn’t all that difficult to estimate.

Fellow contributor Dave Van Knapp’s Lesson 11: Valuation, which is part of an overarching series on DGI, 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…

Tyson Foods, Inc. (TSN)

Tyson Foods, Inc. (TSN) is one of the world’s largest processors and marketers of chicken, beef, and pork.

Founded in 1935, Tyson Foods is now a $19 billion (by market cap) giant in the processed meat space. Employing over 140,000 people, they have sales in over 140 countries worldwide.

US sales represent approximately 87% of revenue.

The company operates across the following segments: Beef, 36% of FY 2019 segment sales; Chicken, 31%; Prepared Foods, 20%; Pork, 10%, and International/Other, 3%.

Some of their major brands include: Hillshire Farms, Jimmy Dean, Ball Park, and the eponymous Tyson.

Most of their sales are split across the retail channel (~45%) foodservice channel (~31%), and international channel (~13%).

I started the article talking about “bedrock” stocks.

These are businesses that cater to basic human needs.

Well, it doesn’t get much more basic than food. We literally can’t survive without food.

While dietary trends are always changing, the world is also growing larger and richer.

More people means more demand for food. And statistics show that protein demand rises as wealth rises. As people gain access to more financial resources, they tend to consume more meat.

This bodes well for Tyson Foods, since they’re one of the largest processors of meats in the world.

It also bodes well for their ability to pay and grow their dividend.

Dividend Growth, Growth Rate, Payout Ratio and Yield

As it sits, Tyson Foods has increased its dividend for eight consecutive years.

The five-year dividend growth rate is 36.6%, which is outstanding.

That monstrous growth comes on top of the market-beating 2.60% yield the stock offers right now.

This yield, by the way, doesn’t just beat the market.

It’s also 120 basis points higher than the stock’s own five-year average yield.

And with a payout ratio of only 30.3%, it’s a well-covered dividend with a large margin of safety.

Revenue and Earnings Growth

Now, this is all looking at what’s already come to pass.

We investors are ultimately risking cash for future results.

Thus, I’ll now build out a forward-looking growth trajectory for Tyson Foods, which will later help us estimate the intrinsic value of the stock.

I’ll first show you what the company has done over the last decade in terms of top-line and bottom-line growth.

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

Blending the proven past with a future forecast like this should allow us to extrapolate a reasonable growth path for the company.

Tyson Foods grew its revenue from $28.430 billion in FY 2010 to $42.405 billion in FY 2019.

That’s a compound annual growth rate of 4.54%.

Really solid. I’m usually looking for mid-single-digit top-line growth from a mature business like this. They nailed it.

Meanwhile, earnings per share rose from $2.13 to $5.52 over this time frame, which is a CAGR of 11.16%.

The excess bottom-line growth seems to be a story of margin expansion. Gross margin and net margin have both expanded nicely over the last 5-10 years.

Looking forward, CFRA is projecting that Tyson Foods will compound its EPS at an annual rate of 1% over the next three years.

A large slowdown in EPS growth over the near term is very possible, considering the massive and sudden drop in demand from the foodservice channel (which represents about 40% of revenue). With restaurants and schools forced to close certain or all aspects of their operations, wholesale foodservice sales will lessen.

However, I think these are short-term issues that will normalize sooner rather than later.

Meantime, the company’s demand for its retail offerings – which actually offer higher margins – have risen as people have been forced to stay at home, so much so that the company adjusted some of its production lines to shift from foodservice channel to the retail channel.

This is meaningful.

Tyson was already growing its percentage of sales from packaged foods, which command more pricing power and higher margins.

Per CFRA, the Prepared Foods segment represented about 10% of sales in FY 2013. Now it’s near 20%. That explains the aforementioned expansion in margins.

This near-term shift therefore actually helps the company in some ways.

CFRA’s near-term EPS growth projection seems very conservative to me, but CFRA is considering the costs that Tyson Foods has been incurring as a result of worker safety, idle plants, and lower production volumes.

As I noted, a near-term drop from the ~11% EPS growth Tyson has logged over the last decade is very possible, if not highly likely.

But going from 11% to 1% is substantial. Too substantial, in my view.

Either way, the low payout ratio protects the dividend and offers the company an ability to modestly increase it in the interim. More impressive dividend growth can return as prior demand returns.

Financial Position

Moving over to the balance sheet, the company maintains a very solid financial position.

The long-term debt/equity ratio is 0.70, while the interest coverage ratio is near 6.

Profitability is sound, and it’s materially improved recently.

Over the last five years, the firm has averaged annual net margin of 4.94% and annual return on equity of 18.0%.

For perspective, net margin was routinely coming in at about 2% prior to FY 2015.

There’s a lot to like about this business.

They have scale, brand recognition, diversification, and a global distribution network.

Their exposure to China, which is their largest international market, is particularly important and exciting – China’s demand for protein is rapidly growing, and China has had a lot of domestic problems (including African swine fever) that have inhibited their supply.

Of course, there are risks to consider.

Litigation, regulation, and competition are ominpresent risks in every industry.

With a large portion of the business being, essentially, a commodity producer, Tyson Foods is more of a price taker than a price maker. Input costs can be volatile.

The COVID-19 pandemic has hit the company in two ways: There’s been reduced demand in foodservice; in addition, they’ve had problems with outbreaks at production facilities.

However, I see this as a short-term risk.

The company is currently in the midst of a DoJ probe regarding possible antitrust violations.

Tyson Foods is highly exposed to viruses and bacteria, both in terms of human beings and animals, which can constrain supply and/or demand.

There is a new food trend regarding alternative meats, although Tyson Foods uses its Tyson Ventures to invest in and advance their opportunities in this area.

And while margins have expanded, they remain somewhat low.

Overall, I see this as a quality business catering to a basic human need, with basically no risk of obsolescence.

At the right valuation, it could be a fantastic long-term investment.

With the stock down 26% YTD, the valuation now appears to be right…

Stock Price Valuation

The stock is trading hands for a P/E ratio of 11.92.

That’s obviously well below where the broader market is at.

It also compares very favorably to the stock’s own five-year average P/E ratio of 14.2.

If we look at cash flow, we see a similar disconnect.

The P/CF ratio is currently 8.3, which is off of the stock’s own three-year average P/CF ratio of 9.8.

And the yield, as noted earlier, is significantly higher than its own 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 10% discount rate and a long-term dividend growth rate of 7.5%.

That’s a conservative DGR.

The company has grown both earnings and its dividend much faster than this over the last decade.

And the payout ratio remains low.

However, I’m also factoring in some near-term headwinds, as well as CFRA’s EPS growth forecast.

I think the odds are good that Tyson actually surprises to the upside here, but I’d rather err on the side of caution.

The DDM analysis gives me a fair value of $72.24.

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 looks at least modestly undervalued to me.

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 TSN as a 4-star stock, with a fair value estimate of $84.00.

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 TSN as a 5-star “STRONG BUY”, with a 12-month target price of $75.00.

My number shows a careful approach. Averaging the three numbers out gives us a final valuation of $77.08, which would indicate the stock is possibly 19% undervalued.

Bottom line: Tyson Foods, Inc. (TSN) is a quality company that’s providing the world with necessary food products. The necessity of eating isn’t something that will be disrupted away. With a market-beating yield, massive dividend growth, a low payout ratio, and the potential that shares are 19% undervalued, this stock looks like one of the few true bargains available in this market.

-Jason Fieber

Note from DTA: How safe is TSN’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 99. 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, TSN’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.

We’re Putting $2,000 / Month into These Stocks
The goal? To build a reliable, growing income stream by making regular investments in high-quality dividend-paying companies. Click here to access our Income Builder Portfolio and see what we’re buying this month.

Source: Dividends and Income