I’ve heard that money doesn’t buy happiness.
Maybe there’s a tinge of truth in this, but I can tell you that poverty buys misery.
I say this from someone who grew up in abject poverty in Detroit, Michigan.
Acquiring ever-more money will probably not move the needle very much on happiness once you have enough to indefinitely cover your lifestyle.
However, not having enough to live comfortably is a surefire way to be unhappy.
It really comes down to becoming financially independent, which I think is the ultimate way to permanently unlock a sense of contentment and satisfaction in life.
And when it comes to achieving financial independence, I’ve found dividend growth investing to be the best path toward that end.
This is a long-term investment strategy that calls for buying and holding shares in world-class businesses that are steadily paying and growing dividends.
You can find hundreds of qualifying stocks on the Dividend Champions, Contenders, and Challengers list, which has a rich data set on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
These are some of the best companies in the world, partially evidenced by those long track records of rising dividends – rising dividends which, in the end, must be funded by rising profits (and rising profits result from businesses doing the right things).
Those rising dividends aren’t just a pretty good initial litmus test for business quality, but also a fantastic foundation for the passive income necessary to cover bills and achieve financial independence.
I’ve been applying this strategy for 15 years, using it to achieve financial independence for myself.
This was achieved through the building of the FIRE Fund, my real-money portfolio which now generates enough five-figure passive dividend income to cover all of my bills.
This dividend income has been enough since I quit my job and put myself in a position to retire in my early 40s.
By the way, if you’re interested in finding out how that happened, make sure to read my Early Retirement Blueprint.
Now, while the dividend growth investing strategy does tend to almost automatically funnel investors right into great businesses, paying sharp attention to valuation at the time of making any investment is critical.
Price only tells you what you pay, but value tells you what 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.
Unlimited money might not buy unlimited happiness, but achieving financial independence through dividend growth investing by buying and holding high-quality undervalued dividend growth stocks can unlock long-term contentment and satisfaction in life.
The preceding discussion on valuation does assume that one already has a basic understanding of valuation.
If that’s not the case for you, Lesson 11: Valuation, which was written by fellow contributor Dave Van Knapp, can help a great deal, as it explains how valuation works and why it’s so important in very simple terms.
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…
Nordson Corp. (NDSN)
Nordson Corp. (NDSN)Nordson Corp. (NDSN) is an American multinational corporation that manufactures equipment used for the precise dispensing of adhesives, coatings, sealants, and other materials.
Founded in 1909, Nordson is now a $12 billion (by market cap) manufacturing powerhouse that employs almost 8,000 people.
Approximately 66% of sales are international.
The company reports results across three segments: Industrial Precision Solutions, 56% of FY 2024 sales; Medical and Fluid Solutions, 26%; and Advanced Technology Solutions, 19%.
Across all three segments, Nordson manufactures a variety of precision dispensing equipment customized for customers and purposes across a range of industries and applications where exactness is required.
It’s an interesting niche to be in, and it’s one that a lot of people might not even think of.
This niche area of manufacturing allows Nordson to quietly fly under the radar, despite the fact that the company has consistently put up great results for decades.
Operating in an under-the-radar niche is what makes a business like Nordson appealing for long-term investors.
It’s a feature, not a bug.
Niches are, by their very nature, small and somewhat limited in TAM, creating a built-in resistance to attracting competition.
A lot of would-be competitors are busy looking for more exciting industries and bigger fortunes, and they can’t be bothered to mess around with small niches.
What this means for Nordson is, it can focus on core operations, do right by customers and shareholders, and quietly compound capital over time with limited interference.
Increasing the appeal factor for investors, Nordson employs the razor-and-blade model; sales are nearly evenly split between systems and parts/consumables.
This split between installed systems and replaceable parts creates recurring revenue with a high degree of sales visibility.
Nordson builds systems designed to work with consumables in a proprietary way.
Once these systems are installed, this presents switching costs and a “sticky” customer base.
On top of all of this, Nordson also has a programmatic acquisition strategy which scales the business beyond what its organic growth opportunities provide for.
The company regularly closes on tuck-in acquisitions that incrementally add to the enterprise’s capabilities, customers, and markets.
All of this helps to explain why the company has been so successful at consistently growing its revenue, profit, and dividend for many, many decades.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, Nordson has increased its dividend for 61 consecutive years.
That’s an incredible track record that underscores the point I just made on the consistency dating back decades.
It’s one of the longer dividend growth track records in existence.
The 10-year dividend growth rate is 14%.
That’s a mind-boggling growth rate for a company that, 10 years ago, was already more than 50 years into consistently growing its dividend ever year.
To be able to grow a dividend at a mid-teens rate after 50+ years of playing the game is extremely impressive.
And guess what the last dividend raise came in at?
14.7%!
Again, I keep coming back to the word “consistent”, which is something Nordson epitomizes.
On top of the mid-teens dividend growth rate, the stock yields 1.5%.
That’s actually not a bad yield at all when you stack it with the growth rate.
A lot of stocks with this kind of growth offer far lower yields.
Even Nordson’s stock doesn’t usually offer this kind of yield.
Indeed, this yield is 60 basis points higher than its own five-year average.
And the dividend is backed by 38.5% payout ratio, indicating a high degree of safety and sustainability.
For long-term dividend growth investors who treasure reliability, Nordson has been one of the most surefire investments over the last half-century.
Revenue and Earnings Growth
As surefire as it’s been, though, a lot of of these dividend metrics are based on the past.
However, investors must always be investing with the future in mind, as today’s capital gets risked for tomorrow’s rewards.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will come in handy for the valuation process.
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 reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this way should give us enough information to roughly gauge where the business may be going from here.
Nordson increased its revenue from $1.7 billion in FY 2015 to $2.7 billion in FY 2024.
That’s a compound annual growth rate of 5.3%.
Not bad at all.
I usually like to see a mid-single-digit (or better) top-line growth rate from a mature business, and Nordson delivered.
Meanwhile, earnings per share grew from $3.45 to $8.11 over this period, which is a CAGR of 10%.
Excellent bottom-line growth out of a niche manufacturer.
Nordson pulled multiple levers in order to drive excess bottom-line growth, including modest buybacks and a large expansion in margins (which I’ll touch on later).
Looking forward, CFRA believes that Nordson will compound its EPS at an annual rate of 5% over the next three years.
CFRA sees much to be excited about when it comes to Nordson, including its expansion efforts, prudent capital allocation, and consistent free cash flow generation.
However, CFRA’s view is that some of these tailwinds will be “…offset by near-term headwinds from inventory destocking and muted industrial activity amid higher rates. Recent data showed U.S. core capital goods orders falling 1.3% and ISM PMI at 48.7, confirming our cautious stance on business equipment spending. We anticipate improving trajectory as [Nordson] executes its “NBS Next” strategy, identifying profitable growth opportunities warranting outsized investment. [Nordson’s] M&A approach targets high-margin, differentiated businesses enhancing its market position, with criteria including differentiated technology portfolios, exposure to high-growth applications, “Nordson-like” gross margins (50%+), and a customer-centric model.”
That last point references Nordson’s acquisitive nature, which I quickly touched on earlier.
A prime example of this is Nordson’s recent acquisition of Atrion Corporation, a leader in proprietary medical infusion fluid delivery and niche cardiovascular solutions.
Nordson’s most recent quarter pointed out that Atrion is performing ahead of expectations, which is great to see.
While I respect the headwinds CFRA outlined, I give Nordson the benefit of the doubt.
It’s just been too consistent for me to act otherwise.
When a company gets it done this reliably, I’m prone to believe that will most likely continue (unless there are clear secular/structural issues presenting themselves).
Nordson’s guidance for its next quarter calls for ~10% YOY growth, which would show that continuation of what Nordson has been doing for a long time – even with the near-term inventory headwinds.
I anticipate Nordson to continue being Nordson, which would lead to double-digit EPS and dividend growth over the coming years.
The stock’s yield won’t appeal to income-seeking investors, but long-term dividend growth investors who appreciate the power of compounding over time should see a lot to like here.
For reference, the stock has delivered a total return of 11.5% annually over the last decade, which is a very nice result that few would be unhappy with.
If we can get a 10%+ dividend growth rate stacked on top of a 1.5% starting yield, that adds up to 11.5%+ (including no valuation compression).
Again, the consistency here is remarkable.
Financial Position
Moving over to the balance sheet, Nordson has a good financial position.
The long-term debt/equity ratio is 0.7, while the interest coverage ratio is over 7.
Admittedly, I’d like to see a better balance sheet, but Nordson’s acquisitive behavior does pressure the balance sheet.
I should point out that Nordson completed its acquisition of ARAG Group, a leader in precision control systems and smart fluid components for agricultural spraying, in 2023, which was Nordson’s largest acquisition ever, and this helps to explain why the balance sheet looks the way it does.
Nordson used to have a much stronger financial position, and I think the higher cash flow from acquisitions will help the firm to trend back into that position over the next five or ten years.
Profitability for the firm is excellent.
Return on equity has averaged 19.6% over the last five years, while net margin has averaged 17.3%.
ROIC is typically in a mid-teens range.
The business routinely generates high returns on capital.
Circling back around to margin expansion story I quickly touched on earlier, Nordson’s net margin was sitting at about 14% a decade ago.
There’s been a meaningful expansion in margins here, and I think a lot of that is owed to accretive acquisitions.
Overall, Nordson is running a great business.
And with economies of scale, a large installed base of equipment, switching costs, R&D, IP (over 2,000 patents and counting), the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
Many of the company’s end markets are cyclical, exposing Nordson to a lot of cyclicality (although 50%+ of sales being recurring does mitigate this risk).
The programmatic acquisition strategy introduces execution, integration, and valuation risks, but management has a proven track record of outstanding capital allocation.
Being an international company, Nordson is exposed to geopolitics and currency exchange rates.
The balance sheet is currently more indebted than usual, which will limit acquisitions and non-organic growth over the near term.
Input costs are variable and largely outside of the company’s control.
These risks should be respected.
But the quality of the enterprise deserves a lot of respect, and the current valuation of the stock doesn’t seem to fully reflect respect it deserves…
Valuation
The stock is currently trading hands for a P/E ratio of 27.4.
Although this isn’t low in absolute terms, it is low in relative terms.
It’s lower than its own five-year average of 30.2.
The sales multiple of 4.5 is also well off of its own five-year average of 5.3.
And the yield, as noted earlier, 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 two-stage dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 5%.
I factored in a 10% discount rate, a 10-year dividend growth rate of 12%, and a long-term dividend growth rate of 8% thereafter.
My near-term assumption for dividend growth basically splits the difference between EPS and dividend growth over the last decade (the latter exceeded the former).
The company seems poised to continue growing its EPS at a ~10% rate, which would set the dividend up for similar growth.
The payout ratio being fairly low does allow for some wiggle room here, but I have a hard time seeing how the dividend will keep growing at its historical 14% rate from here (especially with the balance sheet needing some attention).
Thus, I’m backing that down and assuming an eventual slowdown.
That said, even a slowing would still result in a very acceptable rate of growth, as Nordson would be coming down from impressive levels.
The DDM analysis gives me a fair value of $236.24.
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.
I see a stock that’s mildly 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 NDSN as a 4-star stock, with a fair value estimate of $249.00.
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 NDSN as a 3-star “HOLD”, with a 12-month target price of $220.00.
I came out roughly in the middle. Averaging the three numbers out gives us a final valuation of $235.08, which would indicate the stock is possibly 9% undervalued.
Bottom line: Nordson Corp. (NDSN) is a terrific niche business that generates extremely consistent growth, high returns on capital, and fat margins. Its niche repels new entrants, and it bolsters its competitive position through intelligent acquisitions. With a market-beating yield, a low payout ratio, a mid-teens dividend growth rate, more than 60 consecutive years of dividend raises, and the potential that shares are 9% undervalued, this is a compelling candidate for long-term dividend growth investors who prefer high-quality compounders.
-Jason Fieber
Note from D&I: How safe is NDSN’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 94. 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, NDSN’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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.
Source: Dividends & Income
Disclosure: I’m long NDSN.
