I’ve been investing for more than a decade.
One lesson I’ve learned?
It can be highly beneficial to operate “counterclockwise” to the market.
When everyone else is selling, I’m usually buying.
Warren Buffett summed up this approach best: “…be greedy when others are fearful…”
There has been a lot of fear in the US stock market this year.
Guess what else?
I’ve been greedy.
Running in the opposite direction to the market has greatly helped me over the years, allowing me to build my FIRE Fund in the process.
That’s my real-money portfolio, which produces the five-figure passive dividend income I live off of.
This is even though I’m not even 40 years old yet.
Indeed, I was able to retire in my early 30s.
And my Early Retirement Blueprint explains how.
A pillar of the Blueprint, which relates back to the portfolio, is the investment strategy I’ve used to get here.
That strategy is dividend growth investing.
It’s a strategy that espouses investing for the long term in world-class businesses that pay reliable, rising dividends.
You can find hundreds of examples of these businesses on the Dividend Champions, Contenders, and Challengers list.
Of course, there’s more to it than that.
Price is only what you pay. It’s value that 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.
Being greedy when others are fearful by picking up high-quality dividend growth stocks at rock-bottom valuations puts you in a position to experience spectacular investment results over the long run.
While valuation might seem like a super complicated concept, it’s not.
Fellow contributor Dave Van Knapp put together Lesson 11: Valuation in order to demystify it.
Part of a larger, more comprehensive series of “lessons” on dividend growth investing, it spells out how to go about estimating intrinsic value on dividend growth stocks.
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…
JPMorgan Chase & Co. (JPM) is a financial holding company that operates as one of the largest financial institutions in the United States, with over $3.7 trillion in assets. They offer various financial products and services across traditional retail and commercial banking, asset management, and investment banking.
Founded in 1799, the bank is now a $414 billion (by market cap) global financial leviathan that employs 270,000 people.
The company operates across four major business lines: Corporate & Investment Bank, 43% of FY 2021 net revenue; Consumer & Community Banking, 41%; Asset & Wealth Management, 14%; Commercial Banking, 8%. They also have a Corporate business segment that results in insignificant negative revenue.
With roots dating back to 1799 and the bank’s fabled history intertwining with legendary business magnates such as J.P. Morgan, John D. Rockefeller, Thomas Edison, and Andrew Carnegie, JPMorgan Chase has blossomed alongside the United States of America.
To that point, JPMorgan Chase is a symbol of American financial might. The bank and America itself have become almost inseparable.
This is such a massive and critically important financial institution, it’s almost impossible to imagine what would happen if it were to suddenly disappear.
From retail branches to credit cards to the capital markets, JPMorgan Chase touches pretty much every facet of US finance.
Simply put, it’s a vital part of America’s financial infrastructure.
Morningstar describes the bank like this:
“JPMorgan Chase is arguably the most dominant bank in the United States. With leading investment bank, commercial bank, credit card, retail bank, and asset and wealth management franchises, JPMorgan is truly a force to be reckoned with.”
Another force to be reckoned with? America.
And so I look at the two as a pair.
As long as the United States continues to prosper, so should JPMorgan Chase. With a symbiotic relationship in place, you can’t really separate the two.
The US has been a winning bet for the last 250 years. And I can’t think of a better country to bet on for the next 250 years.
This puts JPMorgan Chase in an excellent position to thrive for many years to come.
In turn, that should consistently translate into higher revenue, more profit, and bigger dividends for shareholders.
Dividend Growth, Growth Rate, Payout Ratio and Yield
As it sits, JPMorgan Chase has increased its dividend for 11 consecutive years.
I think they’re just getting started.
The bank has been making up for lost time with a 10-year dividend growth rate of 16.5%.
And you get to pair this double-digit dividend growth with the stock’s market-beating yield of 2.9%.
This yield, by the way, is 50 basis points higher than its own five-year average.
A low payout ratio of only 26.0% protects the dividend.
I like dividend growth stocks in what I call the “sweet spot” – a yield of between 2.5% and 3.5%, paired with high-single-digit (or better) dividend growth.
The yield is on the low end of the spectrum, but the big dividend growth more than compensates.
Really good dividend metrics here.
Revenue and Earnings Growth
As good as they might be, though, they’re largely looking at the past.
However, investors are risking today’s capital for tomorrow’s rewards.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will later aid in the valuation process.
I’ll first show you what the company has done over the last decade in terms of top-line and bottom-line growth.
I’ll then uncover a near-term professional prognostication for profit growth.
Amalgamating the proven past with a future forecast should give us a reasonably clear picture of the company’s possible growth path from here.
JPMorgan Chase increased its revenue from $97.0 billion in FY 2012 to $121.7 billion in FY 2021.
That’s a compound annual growth rate of 2.6%.
But I think it’s important to keep in mind that JPMorgan Chase is working with a huge sales base. That makes it difficult to rack up impressive relative growth, even if the absolute growth (a ~$25 billion advancement here) is really good.
Also, the last two pandemic-impacted years have been difficult for banks in general.
Meanwhile, the company grew its EPS from $5.20 to $15.36 over this period, which is a CAGR of 12.8%.
That’s more like it. A strong result.
We can now see how they’ve been able to afford such generous dividend raises – EPS growth has funded that activity.
Improving profitability and extensive buybacks combined to propel excess bottom-line growth. Regarding the latter, the outstanding share count is down by approximately 21% over the last ten years.
Looking forward, CFRA believes that JPMorgan Chase will grow its EPS at a CAGR of 2% over the next three years.
This looks disappointing, if not shocking, when we see what the bank put up over the last decade.
To be fair, I think it’s difficult to find accuracy and clarity in this environment.
We have war in Ukraine, raging global inflation, an energy crisis starting to play out in Europe, and the specter of the US Federal Reserve potentially causing a recession by raising interest rates too aggressively.
On the other hand, inflation could be tamed by a combination of higher rates and a normalization of supply chains. Any good news out of Ukraine would be a huge relief to everyone. And rising rates are a tailwind for major banks.
There are a lot of moving pieces.
When there’s so much short-term noise, I find comfort and confidence in staying attuned to the long term.
I have no doubt that the next year or two is going to be tough for the global economy, which undoubtedly impacts the likes of JPMorgan Chase.
Over the long run, however, this is one of the biggest and best financial institutions on the planet. They’ll get their fair share of US and global growth because of it.
Even if near-term EPS growth is only in that low-single-digit range, they still have flexibility on dividend raises.
By virtue of the low payout ratio, there’s room for high-single-digit dividend raises in this environment. And the coming years could see further dividend growth acceleration from that level.
With a 2.9% starting yield, I don’t see anything to dislike about that.
Moving over to the balance sheet, the scope and complexity of their numbers can make it difficult to decipher what’s going on.
But I see nothing to indicate anything less than a rock-solid financial position.
The bank has $3.7 trillion in total assets against $3.4 trillion in total liabilities.
JPMorgan Chase retains the following credit ratings for its senior unsecured debt: A2, Moody’s; A-, Standard & Poors; AA-, Fitch. These ratings are well into investment-grade territory.
Profitability is strong, with steady improvement over the last decade.
Over the last five years, the firm has averaged annual net margin of 27.6% and annual return on equity of 13.1%. Net interest margin came in at 1.6% last fiscal year.
JPMorgan Chase is an absolute powerhouse that’s set to prosper alongside the United States of America.
And with enormous economies of scale, high switching costs, unique financial expertise, and built-up relationships, the company has durable competitive advantages to protect itself.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
I see all three of these risks as elevated for big banks in general.
Banks are directly exposed to economic cycles. A recession, which could be caused by any number of factors, would have a severe and negative impact on the company.
While their absolute size is an advantage, it also limits the relative growth they can produce.
And ongoing technological changes in banking could make it easier for smaller players to take market share.
Even with these risks out in the open, this bank still strikes me as a great long-term investment candidate for dividend growth investors.
The attractive valuation only serves to make me more enthusiastic about it…
Stock Price Valuation
The stock’s P/E ratio is sitting at 9.1.
That’s less than half that of the market’s earnings multiple.
It’s also well below its own five-year average of 13.1.
The P/B ratio of 1.6 is right in line with its own five-year average.
And the yield, as noted earlier, is substantially 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%.
This 7% number looks awfully conservative when you compare it to the bank’s long-term demonstrated dividend and EPS growth.
There’s also the low payout ratio. And we’re in an environment where rates are rising.
All of that bodes well.
However, I also have to account for so much uncertainty. And the near-term EPS growth forecast is somewhat meager.
Overall, I do think the bank can pull multiple levers and meet or exceed this kind of dividend growth rate over both the near term and the long term.
The DDM analysis gives me a fair value of $142.67.
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.
I think I delivered a responsible valuation, yet the stock still looks at least modestly undervalued.
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 JPM as a 3-star stock, with a fair value estimate of $152.00.
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 JPM as a 3-star “HOLD”, with a 12-month target price of $175.00.
I came in low this time around. Averaging the three numbers out gives us a final valuation of $156.56, which would indicate the stock is possibly 12% undervalued.
Bottom line: JPMorgan Chase & Co. (JPM) is a financial powerhouse that’s intertwined with and critical to the United States of America. As the US prospers over the long run, so should the bank. With a market-beating yield, double-digit dividend growth, a low payout ratio, more than 10 consecutive years of dividend raises, and the potential that shares are 12% undervalued, this looks like a great portfolio candidate for long-term dividend growth investors.
— Jason Fieber
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Note from DTA: How safe is JPM’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 60. 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, JPM’s dividend appears Borderline Safe with a moderate risk of being cut. Learn more about Dividend Safety Scores here.
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.