A lot of people think investing is risky.

I think the opposite.

In my opinion, not investing is the riskiest thing you could do.

The world almost demands that you invest.

If you don’t invest and instead just sit on savings, inflation will eventually eat that cash alive by virtue of steadily rising prices over time.

Investing is the only real way you can stay ahead of that monster over time.

And when thinking about all of the different ways one can invest, what immediately comes to mind as the superior method is dividend growth investing.

This is a long-term investment strategy involving the buying and holding of shares in world-class businesses paying out reliable, rising cash dividends to shareholders.

These rising cash dividends can offset, or even beat, inflation – protecting and enhancing purchasing power.

There are hundreds of companies qualifying for this strategy listed on the Dividend Champions, Contenders, and Challengers list – an invaluable source of data on US-listed stocks that have raised dividends each year for at least the last five consecutive years.

You’ll notice some of the world’s best businesses on this list, which shouldn’t be a surprise; it takes a special kind of enterprise to continuously raise profit in order to afford the continuous increasing of cash dividends to shareholders.

This simple logic means the dividend growth investing strategy tends to almost automatically put investors right into great companies.

I’ve used this simple logic for myself over the years, following the strategy as I’ve gone about building the FIRE Fund.

That’s my real-life portfolio, and it generates enough five-figure passive dividend income for me to live off of.

In fact, this is a fortunate position I’ve been in since I was able to quit my job and retire in my early 30s.

By the way, my Early Retirement Blueprint explains how such an early retirement is possible.

A large part of my success came down to living below my means and investing my savings into high-quality dividend growth stocks, but that’s not all.

Valuation at the time of any investment has also been a crucial part of the equation.

The reason is that price only represents what you pay, but value represents 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.

Not investing is the riskiest thing you could do over the long run, whereas living below your means and routinely buying undervalued high-quality dividend growth stocks on your way to financial freedom might just be the smartest thing you could possibly do.

Of course, spotting undervaluation first requires one to know what to look for.

Well, that’s where Lesson 11: Valuation comes in.

Written by fellow contributor Dave Van Knapp as part of a series of “lessons” designed to teach the dividend growth investing strategy, it lays out the ins and outs of valuation using simple terminology so that the reader can confidently go out and value businesses on their own.

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…

EOG Resources Inc. (EOG)

EOG Resources Inc. (EOG) is an American energy company that engages in hydrocarbon exploration and production.

Founded in 1999, EOG Resources is now a $61 billion (by market cap) O&G enterprise that employs approximately 3,000 people.

EOG Resources primarily operates across a number of US shale fields and basins, including Williston Basin, Powder River Basin, DJ Basin, Anadarko Basin, Barnett Shale, Permian Basin, Eagle Ford, Dorado, South Texas, Utica, and the Columbus Basin.

The company finished FY 2024 with net proved reserves at 4.7 billion barrels of oil equivalent (worth roughly 13 years of production), which increased by about 5.5% YOY.

Average daily production was just over 1 million boe/d in 2024 (up nearly 8%YOY).

Oil & gas companies have historically only been “okay” businesses to invest in.

On one hand, these companies are providing the world with energy products we can’t viably live without in a modern-day society.

Without power, everything stops.

Companies like EOG Resources are critical to our collective way of life.

Although we’re starting to bring new energy production methods online – such as solar – the world is still largely powered by hydrocarbons.

Being in a position of near-necessity means these companies can be alluring investments for long-term investors wanting a certain amount of visibility well into the future.

These companies are simply highly unlikely to become irrelevant at any point over the next several decades, as demand for energy is steadily rising.

While developed countries are demanding more energy from the usage of energy-hungry technology (such as AI), developing countries are also demanding more energy as they consume and build their way into development.

Meantime, hydrocarbons have finite supply.

Despite this very interesting setup, as I mentioned earlier, the stocks largely haven’t been home runs over the last decade or so.

Why?

Well, these companies are price takers, not price makers, involved in the production and supply of commodities that are subject to market forces largely out of these companies’ control.

This has led to choppy business results, which has bled through into choppy stock movements.

However, in recent years, these companies (and their underlying shares) have become far better investments.

Whereas the industry used to abide by a “drill, baby, drill” methodology, maximizing production and revenue in the pure absolute sense – often at the expense of profitability – the industry has become far more rational since the pandemic, focusing more on the production of cash flow than hydrocarbons via low operating costs and careful moderation of supply.

EOG Resources has been particularly emblematic of this, hammering its costs down to the minimum.

Morningstar highlight just how successful EOG Resources has been on this front: “In EOG’s case, leading well production allows EOG to enjoy some of the lowest cash operating costs in our US E&P coverage. In fact, since 2016, on a rolling quarterly basis, EOG’s cash operating costs are on average over 20% lower than its US E&P industry peer set.”

With costs down, profitability and returns to shareholders can go up.

Yet, the market may not have totally caught on to this yet, still punishing most O&G stocks with rock-bottom valuations for past wrongs.

We have a very favorable inflection point possibly afoot, with new dynamics meeting old valuations.

While those buying in now wait for the market to catch up to the new reality and more appropriately value the business, they get to affordably invest in a world-class oil & gas company reliably generating higher revenue, profit, and dividends.

Dividend Growth, Growth Rate, Payout Ratio and Yield

To date, EOG Resources has increased its dividend for eight consecutive years.

Not the longest track record out there, but I really do believe that EOG Resources is still in the early chapters of its dividend growth story.

The 10-year dividend growth rate of 21.7% shows what a start that story has gotten off to, although the growth has come in fits and spurts (not unsurprising, given the volatility of underlying commodities).

Despite the outsized dividend growth, the payout ratio is only 40.6% – very healthy and supportive of the current dividend level.

Along with the consistent and high dividend growth, the stock offers a yield of 3.7%.

That’s far higher than what the broader market will give you.

This yield is also 130 basis points higher than its own five-year average, giving those buying in now much more income in the here and now (relative to those who have bought in the past at a lower yield).

The spread here also gives us an early indication of undervaluation.

But wait.

There’s more.

This yield doesn’t fully encapsulate what this stock offers.

The 3.7% number is only reflective of the regular quarterly dividend, but EOG Resources frequently pays out special dividends on top of those regular payouts.

Those special dividends are dependent upon an especially good backdrop for commodities, which isn’t where we’re at right now (WTI is at ~$60 per barrel), but this is nice income optionality above and beyond what is already a very nice base setup.

Overall, this dividend profile offers something for everyone.

You get yield, growth, and safety all in one package.

Tough to dislike anything here.

Revenue and Earnings Growth

As likable as it may be, though, this profile is largely drawn up using past data.

However, investors must always be thinking about possible future data, as today’s capital gets put on the line and 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 when the time comes later to estimate fair 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 reveal a professional prognostication for near-term profit growth.

Amalgamating the proven past with a future forecast in this way should give us a base upon which we can confidently sketch out where the business could be going from here.

EOG Resources advanced its revenue from $8.8 billion in FY 2015 to $23.7 billion in FY 2024.

That’s a compound annual growth rate of 11.6%.

Pretty incredible top-line growth for an O&G company.

This is competitive with higher-growth companies in areas of the economy such as technology, making this quite impressive.

Meanwhile, earnings per share grew from $4.46 to $11.25 from FY 2017 to FY 2024, which is a CAGR of 14.1%.

I advanced EPS to FY 2017 due to GAAP losses for FY 2015 and FY 2016 (circling back around to the less favorable industry dynamics that existed at that time, which I discussed at length earlier).

Again, very strong growth.

Now, it should go without saying that a lot of this depends on the starting and ending points, as commodities are extremely volatile.

The last decade or so is putting EOG Resources in its best light, as the entire industry was undergoing a rationalization and improvement.

However, all of those improvements are more structural in nature, which should provide lasting tailwinds to the likes of EOG Resources over the coming decades.

Looking forward, CFRA is projecting that EOG Resources will compound its EPS at an annual rate of 4% over the next three years.

It’s doubly difficult to forecast the growth for a company like EOG Resources, as one is thinking about not only the company itself but also underlying commodities (which are subject to global market forces).

There are more moving targets than normal.

That said, CFRA is basing this on a $70/barrel WTI target for 2026, which is not terribly optimistic.

CFRA specifically highlights the “double premium” strategy for EOG Resources, which targets 60%+ after-tax real rates of return at conservative $40 WTI/$2.50 gas assumptions.

The conservative nature of EOG Resources in terms of its cost structure and its funding/project hurdles is exemplary, in my view.

The corporate graveyard is filled with O&G companies that weren’t conservative through the cycles and couldn’t survive the tough times.

One interesting and exciting addition to the EOG Resources arsenal is its recent $5.6 billion acquisition of Encino Acquisition Partners.

CFRA states: “EOG’s $5.6B Encino acquisition adds 235k boe/d production, boosting Q2 output 20% and significantly strengthening Utica position.”

That sounds great to me.

CFRA then highlights the company’s “…strategic positioning across key liquids-rich plays, with Encino adding foundational Utica pillar alongside Delaware Permian and Dorado. Acquisition timing appears advantageous as gas recovers to low-$4s. About 75% of 2020 cost cuts remain sustainable through innovation rather than service reductions. Utica acreage supports data center growth tied to AI expansion in MidAtlantic region. EOG’s returns focus predates pandemic; Encino delivers 55% returns at bottom-cycle pricing.”

Favorable pricing, additional output/reserves, data center/AI exposure, and high returns.

EOG Resources was already one of the best domestic O&G companies, and the Encino acquisition only serves to improve upon that.

CFRA’s projection leaves a lot of room for EOG Resources to surprise to the upside, but even a mid-single-digit bottom-line growth rate still supports like-or-better dividend growth over the near term, with even more to look forward to under a better pricing framework.

If you blend that together, that puts shareholders in a good spot to expect something along the lines of high-single-digit dividend growth (averaged out) over the long haul.

That would be coming on top of the near-4% starting yield – along with possible special dividends along the way.

I really can’t understand what there is to dislike about that.

Assuming one has room for O&G in their portfolio, and assuming one isn’t opposed to investing in the industry, this strikes me as one of the better long-term opportunities available.

Financial Position

Moving over to the balance sheet, EOG Resources has a stellar financial position.

The long-term debt/equity ratio is 0.1, while the interest coverage ratio is over 50.

As strong as these numbers are, they don’t do the balance sheet full justice.

I say that because EOG Resources has a net cash position on the balance sheet.

Companies in the O&G space used to run a lot of leverage, which is obviously not a good idea when you’ve got price takers exposed to so much cyclicality, but this kind of balance sheet strength (which isn’t limited to only EOG Resources) illustrates just how much the industry has changed and improved over the last decade or so.

For perspective on this, cash has increased by about tenfold over the last decade, whereas long-term debt is down by about 1/3 over the same period.

Profitability is another area of strength and improvement.

Return on equity has averaged 21.2% over the last five years, while net margin has averaged 21.6%.

This is extraordinary.

It’s probably surprising to see this kind profitability from this specific business model.

You might expect to see such high returns on capital from a tech company, and this really does reinforce the overarching theme here of radical enhancement for the industry, in general, and EOG Resources, in particular.

Overall, from top to bottom, EOG Resources has a wonderful business on its hands.

And with economies of scale, low-cost operations, barriers to entry, and favorable acreage, 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.

Regulation, in particular, is a thorny issue in this industry, but more regulation can actually counterintuitively be a boon (by suppressing supply, thereby increasing commodity prices).

While the world still requires hydrocarbons for energy, there’s a risk over the very long run that renewable forms of energy will eventually displace oil & gas completely.

It’s a capital-intensive business model which is simultaneously highly cyclical.

Being a commodity business which is highly dependent on its underlying commodity pricing, EOG Resources is a price taker (not a price maker).

The company’s reserves must continually be added to so as not to risk running out of supply.

Fields naturally get depleted over time, and there is uncertainty regarding how much supply is left in the world.

The industry sees constant pressure from some environmental groups, which may result in negative goodwill across some parts of society.

I certainly see some risks here, many of which have long been standard for the industry – despite the industry’s standard rising so much.

Yet, with the stock down 25% from its recent high, the valuation does not seem to reflect how much better this business has become…

Valuation

The P/E ratio is now sitting at 10.9.

That’s less than half that of the broader market’s earnings multiple.

This is also below the stock’s own five-year average P/E ratio of 11.5 – which is already low to start with.

For a company that’s been growing at a double-digit rate, a P/E ratio barely over 10 is almost absurd.

This kind of stock simply doesn’t get respect from the market, still weighed down by the unfavorable industry dynamics of the past.

The P/CF ratio of 5.5, which is lower than its own five-year average of 6.4, further shows just how cheap this stock is.

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%.

Circling back around to what I stated earlier, blending the last decade of proven results, near-term growth projection, and long-term prospects for the business and industry, high-single-digit dividend growth (averaged out, and back-loaded) is a very reasonable expectation to have.

The business has compounded at a double-digit rate over the last decade, and the dividend has been growing briskly.

However, I put that up against near-term weakness in WTI.

While the next year or two might be more middling in nature, EOG Resources has what it takes to deliver powerful dividend growth over time.

The business is almost too good, and the industry is almost too improved, to materially disappoint.

The DDM analysis gives me a fair value of $145.52.

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.

From everything I can see, this stock appears to be priced cheaply relative to its intrinsic value.

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 EOG as a 4-star stock, with a fair value estimate of $139.00.

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 EOG as a 4-star “BUY”, with a 12-month target price of $135.00.

I ended up slightly high, but we appear to be in broad agreement about the appeal of the valuation right now. Averaging the three numbers out gives us a final valuation of $139.84, which would indicate the stock is possibly 20% undervalued.

Bottom line: EOG Resources Inc. (EOG) is a high-quality oil & gas company that has become better in almost every way over the last several years. Despite radical improvement, the entire industry seems to be in a kind of permanent purgatory, benefiting those who can see past prior errors and take advantage. With a market-smashing yield, double-digit dividend growth, a low payout ratio, nearly 10 consecutive years of dividend increases, and the potential that shares are 20% undervalued, long-term dividend growth investors looking to bump up their energy exposure should seriously consider this name right now.

-Jason Fieber

Note from D&I: How safe is EOG‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 82. 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, EOG‘s dividend appears Very Safe with an 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 EOG.