Being born in the USA is a gift.

But many people don’t fully appreciate it.

The opportunities, economic and otherwise, are immense.

While it’s easy to point to education and income advantages among Americans, there’s another big advantage that is often not utilized.

It relates to the US stock market.

The US stock market is the largest, most liquid, and most developed market for stocks in the whole world – by far.

And since stocks are simply slices of real businesses, what this really says is that the US is fertile ground for business success.

Being born in America gives one easy access to that success and the ability to personally profit from it, yet it’s reported that nearly half of Americans fail to participate in this by not owning stocks.

That’s a shame.

However, if you’re reading this, I assume you’re already “in the know”.

But what you may not be fully aware of is how best to capitalize on American capitalism.

I’m referring to dividend growth investing.

This is a long-term investing strategy whereby you buy and hold shares in world-class businesses that pay reliable, rising dividends to their shareholders.

It’s intuitive, but also effective, in the way it filters investors straight into the great businesses in the best system.

After all, only great businesses can reliably increase their profit in order to afford reliably increasing dividend payments.

You can see what I mean by checking out the Dividend Champions, Contenders, and Challengers list.

This list is a compilation of hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.

For the first 28 years of my life, I took my global station for granted.

Just before my 28th birthday, I realized how fortunate I was and started to make up for lost time by aggressively living below my means and investing my savings into high-quality dividend growth stocks.

That’s how I built the FIRE Fund.

This is my real-money portfolio, and it produces enough five-figure passive dividend income for me to live off of.

Indeed, I’ve been able to live off of dividends for years now.

I actually quit my job and retired in my early 30s.

How did I go from zero to hero so quickly?

My Early Retirement Blueprint lays it out.

My overarching strategy has been a key element of my success, sure.

But it’s not about just which stocks I’ve been buying.

It’s also about the valuations at time of buying.

Price is what you end up paying, but value is what you end up getting.

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 high-quality dividend growth stocks when undervaluation is present is one of the easiest and yet most effective ways to take full advantage of American capitalism and become financially independent over time.

Of course, all of this is is more difficult if one doesn’t understand how valuation works.

Fear not.

Dave Van Knapp, fellow investor and colleague, put together Lesson 11: Valuation in order to make the valuation process more understandable and actionable.

It’s part of a comprehensive series of “lessons” on dividend growth investing that are designed to “teach” the strategy from start to finish.

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 an $18 billion (by market cap) food giant that employs over 140,000 people.

The company has sales in over 140 countries worldwide, but approximately 84% of sales come from the US market.

The company reports results across the following segments: Beef, 36% of FY 2022 segment sales; Chicken, 31%; Prepared Foods, 17%; Pork, 12%, and International/Other, 4%.

Tyson Foods offers prepared foods via a number of brands, including: Hillshire Farms, Jimmy Dean, Ball Park, and the eponymous Tyson.

Sales by channel are split across the retail channel (~44%), foodservice channel (~41%), and international channel (~15%).

There are a few things that human beings need in order to survive.

Oxygen and water come to mind immediately.

So does food.

If you don’t eat, you don’t survive.

Beyond basic survival, though, most people want to enjoy food.

That often leads right to proteins.

This is why there’s built-in demand for proteins.

But that’s not all.

This built-in demand is growing.

There are two reasons for that.

First, the world’s global population continues to see its average wealth rise over time.

Proteins can be unaffordable for those in the lowest socioeconomic tiers.

As people gain access to more financial resources, there’s a natural tendency to consume more proteins.

Second, our species continues to escalate in number.

The global population of humans crossed over the 8 billion mark not long ago.

More people to feed only serves to put pressure on the base demand for food.

All of this plays right into the hands of Tyson Foods, which is one of the largest processors of proteins on the planet.

As such, the company’s revenue, profit, and dividend should continue to grow over the long term.

Dividend Growth, Growth Rate, Payout Ratio and Yield

Already, Tyson Foods has increased its dividend for 11 consecutive years.

A pretty decent start that could lead to something great.

More than decent is the 10-year dividend growth rate of 27%, which is outstanding.

However, it’s also misleading.

Recent dividend raises have been in the mid-single-digit range.

The last dividend boost came in at 4.4%.

And I’d expect that kind of dividend growth, or worse, to persist, at least for the next few years, as a lot of the larger dividend raises in the past were funded by expanding the payout ratio.

To that point, the payout ratio is now 43.8%, based on TTM adjusted EPS.

Not terribly high.

But also not close to 0%, as it was 10 years ago.

Furthermore, the business has been struggling of late.

And that will put more downward pressure on near-term dividend growth, although things could improve quite a bit once Tyson Foods gets through this “air pocket”.

That’s the bad news.

There’s also good news.

The stock yields 3.8%, which is nearly unheard of for this stock.

We’re talking about a yield that’s competitive with utilities.

For perspective, this yield is 150 basis points higher than its own five-year average.

Another way to look at it is, this yield is almost twice as high as it usually is.

So what’s happened here is, the market has adjusted the price and yield in order to compensate for the lower dividend growth rate.

A pretty fair trade-off, in my view, assuming that growth isn’t permanently impaired.

For income-oriented dividend growth investors, these are interesting numbers.

Revenue and Earnings Growth

As interesting as the numbers may be, though, these metrics are mostly looking into the past.

However, investors must look into the future, as today’s capital is being risked for tomorrow’s rewards.

As such, I’ll now build out a forward-looking growth trajectory for the business, which will be of great use when the time comes later to estimate intrinsic value.

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

I’ll then uncover a professional prognostication for near-term profit growth.

Lining up the proven past with a future forecast in this manner should allow us to come to a reasonable conclusion about where the business might be going from here.

Tyson Foods increased its revenue from $34.4 billion in FY 2013 to $53.3 billion in FY 2022.

That’s a compound annual growth rate of 5%.

Not bad at all.

I usually look for a mid-single-digit top-line growth rate from a fairly mature business like this.

Tyson Foods is right on target.

Meantime, earnings per share grew from $2.12 to $8.92 over this period, which is a CAGR of 17.3%.

Impressive bottom-line growth.

However, again, we have a growth rate that’s misleading.

The company’s results are lumpy, so the impressiveness (or lack thereof) of its growth largely depends on what specific time frame you’re looking at.

The company saw outsized margins, particularly on beef, during the pandemic, but this trend has totally reversed course.

Recent results have been downright poor.

For instance, Tyson Foods reported a loss for Q2 FY 2023, its latest quarter.

Margins were challenged, and management is responding with improved focus and cost-cutting efforts.

Like many businesses, Tyson Foods has been whipsawed.

In the end, though, people still have to eat.

And it’s hard to imagine Tyson Foods not righting the ship, even if it takes some time to do so.

Looking forward, CFRA is projecting that Tyson Foods will compound its EPS at an annual rate of -16% over the next three years.

Yes, that’s a negative growth rate.

Not good.

I’m not extremely sanguine about Tyson Foods, and it’s far from my favorite business, but this is an awfully pessimistic take.

Keep in mind, CFRA had this projection at -5% as recently as early February.

CFRA wasn’t exactly enthusiastic before, but this is a big change in a short period of time.

On one hand, CFRA notes that Tyson Foods is “well-positioned to benefit from the growing demand for protein, particularly overseas as most of the protein consumption growth is expected to occur outside of the U.S. (mostly in Asia) over the next decade from population and income growth. [Tyson Foods] is expanding capacity domestically and overseas to capture this growth.”

I mean, the basic business model is not in question.

It’s really a self-help story around execution.

CFRA digs into that with this passage: “Operating margins in Beef, Chicken, and Pork are currently under pressure due to high cattle prices, elevated feed costs, supply/demand imbalances, ineffective hedging strategies, the strong U.S. dollar, and operational miscues (mainly in Chicken). We expect Beef margins to remain well below [Tyson Foods]’s long-term outlook of 7%-9%. In Chicken, we sense a lot of work ahead to remove inefficiencies and improve execution. On the positive side, we like the investments [Tyson Foods] is making to improve productivity ($400M+ productivity savings targeted in FY ’23), including automation and supply chain planning tools.”

In my view, the near term will not be pretty.

But if one has long-term time horizon, the turnaround potential is clearly there.

I think dividend raises over the next year or two will be very small, and it wouldn’t surprise me to see some pauses in there.

However, I don’t see immediate risk to the dividend.

And once the business moves past this storm, dividend growth from FY 2025 and beyond could pick up quite nicely.

One could just wait for that turnaround to show up, but the market is likely to sniff it out and start to price it in beforehand.

The market is, after all, anticipatory.

Overall, I think it’s reasonable to expect a mid-single-digit dividend growth rate from Tyson Foods over the long term, even if it’ll be lumpy along the way.

Financial Position

Moving over to the balance sheet, Tyson Foods has a good, but not excellent, financial position.

The long-term debt/equity ratio is 0.4, while the interest coverage ratio is nearly 7.

Profitability is also just good.

Over the last five years, the firm has averaged annual net margin of 5.6% and annual return on equity of 16.9%.

Tyson Foods has undoubtedly seen better days, but it’s also hard to imagine that better days aren’t ahead.

There are temporary, executional issues present, not existential questions around the business model.

And with economies of scale, an established global distribution network, and brand power, the company does benefit from durable competitive advantages.

Of course, there are risks to consider.

Regulation, litigation, and competition are omnipresent risks in every industry.

Since Tyson Foods is largely a commodity producer, it’s more of a price taker than a price maker.

Input costs can be volatile, and these costs have been rising.

Viruses, like flus, sometimes hit animals and cause massive harm to herd and/or flock health.

Alternative food products, like lab-grown meat, could challenge the business model in the future.

There is a risk that recent stumbles are foreshadowing structural problems.

Tyson Foods is mostly a US player, but its exposure to foreign markets introduces geopolitical and currency risks.

I think these risks should be carefully thought over, but the basic necessity of the company’s products also needs to be considered.

Another aspect worth considering is the valuation, which looks quite attractive after the stock’s 40%+ fall from its recent high…

Stock Price Valuation

The stock’s P/E ratio is 12.3.

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

What makes this especially notable is that earnings are basically in a trough right now.

If earnings were more normal, this ratio would probably be under 10 at an unchanged stock price.

Sales haven’t been impacted as much as earnings, and this really shows how low the valuation is.

The P/S ratio of 0.3 is half of its own five-year average of 0.6.

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 6.5%.

Now, there are two ways to look at this growth rate.

On one hand, it’s on the low end of what I usually allow for, and it’s quite a bit lower than the company’s demonstrated growth across its EPS and dividend over the last decade.

On the other hand, it looks high when compared to recent bottom-line and dividend growth, and the near-term forecast for EPS growth, which is abysmal, can’t support any dividend growth at all.

I’m looking through this “valley” the business finds itself in right now.

An established, scaled-up business in food processing should be able to muster mid-single-digit dividend growth over the long run, assuming it stays out of its own way.

Recent actions around execution show that management is aware of the situation and committed to improving, so I don’t believe that Tyson Foods will snatch defeat from the jaws of victory.

There is a lack of extreme enthusiasm on my part, as I just don’t see sustained excellence in the fundamentals, but Tyson Foods is being priced for downright misery.

If the business can just get back to normal, there’s a lot of upside from here.

I believe the next year or two could be tough in terms of dividend growth, but FY 2025 and beyond should allow Tyson Foods to make it up to shareholders.

The DDM analysis gives me a fair value of $58.42.

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 don’t see how I was being aggressive at all with the valuation, 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 TSN as a 5-star stock, with a fair value estimate of $96.00.

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 3-star “HOLD”, with a 12-month target price of $59.00.

I came out within pennies of where CFRA is at on this one. Averaging the three numbers out gives us a final valuation of $71.14, which would indicate the stock is possibly 28% undervalued.

Bottom line: Tyson Foods Inc. (TSN) is in the business of selling something people literally can’t live without. And with the world growing larger and richer, demand for its products should only rise over time. With a market-smashing yield, a moderate payout ratio, a double-digit long-term dividend growth rate, more than 10 consecutive years of dividend increases, and the potential that shares are 28% undervalued, long-term dividend growth investors looking for a turnaround play oughta have their eyes in this direction.

-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 D&I: 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 90. 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.

Source: Dividends & Income