We all know you can’t buy time.
Or can you?
While this is technically correct – time can’t actually be purchased anywhere – it is possible to create a life with more free time.
Having more free time in your life and being able to do more of what you want is akin to “buying” time – even if you still have the same 24 hours per day.
Setting up this kind of life is possible, but it requires achieving financial freedom.
And achieving financial freedom is, perhaps, most realistic for the average person by employing the dividend growth investing strategy.
This long-term investment strategy advocates buying and holding shares in high-quality businesses rewarding shareholders with reliable, rising cash dividend payments.
Growing dividend income – once you have enough to cover the bills – can be the solid foundation underpinning financial freedom.
You can find hundreds of businesses qualified for this strategy and paying out those growing dividends by taking a look at the Dividend Champions, Contenders, and Challengers list.
This list has compiled invaluable information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
As you might imagine, there are many household names on this list.
These are some of the best businesses in the world, as being able to afford to pay out steadily rising cash dividend payments to shareholders means steadily generating more and more profit – something only possible when a business is up to a certain standard.
I’ve been following this methodology over the past 15 years, and it helped me to achieve the very financial (and time) freedom I just outlined.
In fact, I was even able to quit my job and retire in my early 30s, which is something my Early Retirement Blueprint details.
My freedom is underpinned by the five-figure passive dividend income I now life off.
This passive income is created by the FIRE Fund – my real-money portfolio.
While a lot of my success has been predicated on investing in the right businesses, investing at the right valuations has also been 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.
We can’t literally buy time, but we can figuratively buy time by living below our means, buying undervalued high-quality dividend growth stocks, building up enough growing passive income to live off of, and achieving financial freedom.
Now, being able to spot and buy undervalued securities first necessitates an understanding of the whole concept of valuation.
This is why fellow contributor Dave Van Knapp wrote Lesson 11: Valuation, which is part of an overarching series of “lessons” designed to teach the dividend growth investing strategy.
It lays out the concept of valuation using simple terminology and even provides a valuation template you can apply toward almost 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…
DTE Energy Co. (DTE)
DTE Energy Co. (DTE)DTE Energy Co. (DTE) is an American electricity and gas utility company.
Founded in 1849, DTE Energy is now a $27 billion (by market cap) diversified energy player.
Based and operating in the state of Michigan, DTE Energy provides approximately 2.3 million customers with electricity utility services; it provides approximately 1.3 million customers with gas utility services.
DTE Energy provides its services to retail, commercial, and industrial customers.
Its 2024 electricity generating capacity was nearly 34% coal, around 32% gas, 15% renewables, just over 9% nuclear, and slightly over 9% hydroelectric.
A power utility company, like DTE Energy, can be an appealing long-term investment.
Much of that appeal comes down to the resiliency, reliability, and visibility inherent in the business model.
See, DTE Energy’s customers cannot viably live without the services it’s providing.
If the choice is paying the utility bill or living without power, there’s really no choice at all.
And since every local territory within the US almost always has only one local utility provider, these beholden customers are completely reliant upon just that one company.
There’s nowhere else to go.
You can’t ask for a more “sticky” form of recurring revenue.
However, there’s a caveat.
Because of how much leverage any local utility company has over the local populace, regulators heavily regulate these companies and put a ceiling on how much profit they can make.
In my view, this is sensible; otherwise, it’d be too easy to take advantage of society.
But that regulation is a double-edged sword, as utility companies are essentially guaranteed (by those same regulatory bodies) a solid return on investments made through allowable rates.
Combined with the necessary nature of power, this regulator-supported floor underneath a utility company is extremely strong.
What you end up with is a business model that usually avoids extreme outcomes, creating an easy investment thesis with mappable revenue, profit, and dividend progress over time.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, DTE Energy has increased its dividend for 16 consecutive years.
Its 10-year dividend growth rate of 7.3% is strong.
It’s on the higher end when you look across the regulated power utility space (which often features dividend growth rates in the 5% to 6% area).
And the consistency has been remarkable.
The five-year dividend growth rate is 7.3%, and so is the three-year dividend growth rate.
The most recent dividend raise, which was announced only weeks ago, was nearly 7%.
This thing is clockwork.
And you’re able to stack that consistent 7% dividend growth on top of the stock’s starting yield of 3.6%.
This yield easily beats what the broader market will give you.
It’s also 30 basis points higher than its own five-year average.
With a payout ratio of 70%, this elevated yield is not in trouble.
Assuming no major change to the valuation, that combination of yield and growth can get you to a 10%+ annualized total return, which is very solid for a regulated utility.
And a good chunk of that return is coming in the form of dividend income, making this name appealing for those who favor yield.
Revenue and Earnings Growth
As appealing as it may be, though, that appeal is mainly derived from past events.
However, investors must always be thinking about possible future outcomes, as the capital of today is risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will be of use during 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.
And I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this manner should give us the ability to roughly gauge where the business could be going from here.
DTE Energy moved its revenue from $10.3 billion in FY 2015 to $12.5 billion in FY 2024.
That’s a compound annual growth rate of 2.2%.
Not bad.
Not atypical for a regulated power utility.
You get steady rate and revenue advancement, but it’s not otherworldly.
Meanwhile, earnings per share grew from $4.05 to $6.77 over this period, which is a CAGR of 5.9%.
This is right about what I’d expect out of this business.
Circling back around to what I mentioned earlier, I tend to see a lot of regulated power utilities generate this kind of growth.
Since it’s now clear that dividend growth has been modestly outpacing EPS growth, we should expect to either see EPS growth accelerate or dividend growth moderate.
Which one will it be?
Looking forward, CFRA believes that DTE Energy will compound its EPS at an annual rate of 8% over the next three years.
There you go.
Faster EPS growth it is.
Since EPS has been growing approximately one percentage point slower than the dividend over the last decade, now growing one percentage point faster would right the ship and cause an equilibrium.
Supporting its belief, CFRA cites: “higher customer rates, returns on capital investments, and operating and maintenance cost control efforts.”
CFRA also notes a constructive regulatory environment (specifically pointing out a recent 9.9% authorized ROE) and demand growth from data centers.
Zooming in on that last point, CFRA highlights: “DTE executed a 1.4 GW data center agreement with a hyperscaler during Q3, with demand ramping over the next two to three years. The data center will pay for storage under a 15-year contract. The company is in discussions with hyperscalers for an additional 3 GW of load.”
That’s big.
This is obviously where the catalyst for a bottom-line growth acceleration is, which would support continued 7% dividend growth.
It’s just more sustainable now than it was before, allowing for some slight payout ratio compression (versus the expansion that had been occurring before).
And one is already starting out with a healthy yield creeping up on 4%.
In my view, that’s one of the better setups in the regulated power utility space.
Financial Position
Moving over to the balance sheet, DTE Energy has a decent financial position.
The long-term debt/equity ratio is 1.8, while the interest coverage ratio is slightly over 2.
Notably, long-term debt has more than doubled over the prior decade.
Now, that’s not totally surprising, as regulated power utilities rely on equity and debt in order to fund growth projects (which, as noted earlier, get regulator-supported returns on investment).
With utilities, you tend to see growth across revenues, profits, dividends, and debt loads.
It’s just part of the industry.
DTE Energy does command investment-grade credit ratings: BBB, Fitch, BBB+, S&P.
This balance sheet strikes me as being on the weaker side, relative to the continuum of all regulated power utilities, but it’s also not completely out of line or terrible.
Profitability for the firm is great, being at the higher end of what I typically see.
Return on equity has averaged 11.3% over the last five years, while net margin has averaged 9.2%.
This ROE is quite strong, speaking on the favorability of the regulatory environment (which is something CFRA touched on).
Combining a friendly regulatory environment with large local data center investments bodes well for DTE Energy and its shareholders over the coming years.
And with economies of scale, a geographic monopoly over its territory, beholden customers, and a regulatory framework that just about guarantees some level of profit, 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 is a double-edged sword: Regulators allow for utilities to make a reasonable profit, where profit scales with costs, putting a profit floor in place; however, because electricity is a basic necessity and there’s often only one power provider in any one geographic area, regulators put a profit ceiling in place by limiting the rates a utility can charge.
This is a rare industry in which competition at a local level doesn’t exist, as DTE Energy has a monopoly across its territory, but it’s possible that customers will become future competitors by generating power at the site of consumption (through solar installations).
DTE Energy is dependent on the evolving regulatory structure and population growth of Michigan, but Michigan’s current regulatory situation is constructive.
The company has exposure to nuclear and the risks therein.
There is limited natural disaster risk present, although Michigan does suffer through occasional blizzards and tornadoes.
The balance sheet is stretched, but this is offset by highly steady and visible revenue.
Overall, I see pretty standard risks here.
But the valuation is currently not at its standard lofty level after a recent pullback in the shares, presenting what could be a rare opportunity to invest in an above-average utility operation…
Valuation
The stock is currently trading hands for a P/E ratio of 19.4.
In absolute terms, that’s not shockingly low.
However, it is just slightly below its own five-year average of 19.6.
The cash flow multiple of 7.9 is likewise slightly below its own five-year average of 8.1.
And the yield, as noted earlier, is 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% dividend growth rate is at the higher end of what I’d typically use for a power utility, which is usually a slower-growth type of business, but DTE Energy has been extremely consistent with handing out dividend raises in the 7% area over the last decade.
Like I said before, it’s been clockwork.
While some of that consistency has been afforded by a small, steady expansion in the payout ratio, an acceleration in EPS growth over the next several years will correct that and allow for more sustainable 7% dividend growth.
I think 7% is a very reasonable expectation to have.
The DDM analysis gives me a fair value of $166.21.
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.
Unless DTE Energy is going to suddenly go off track with dividend growth, the stock looks attractively valued 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 DTE 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 DTE as a 4-star “BUY”, with a 12-month target price of $154.00.
We have a bit of a spread here, but every number is higher than the current pricing. Averaging the three numbers out gives us a final valuation of $153.07, which would indicate the stock is possibly 15% undervalued.
Bottom line: DTE Energy Co. (DTE) has long been a great power utility business operating in a constructive regulatory environment. But new data center investments in its area, which will result in a big jump in demand for power, stand to make the business even better. With a market-beating yield, high-single-digit dividend growth, an acceptable payout ratio, more than 15 consecutive years of dividend increases, and the potential that shares are 15% undervalued, long-term dividend growth investors have an opportunity to acquire a nice mix of value, quality, and income here.
-Jason Fieber
Note from D&I: How safe is DTE‘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, DTE‘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 have no position in DTE.
