There are so many things I love about investing.
One thing?
Even repeated mistakes can still lead to great outcomes.
One of the greatest investors ever, Peter Lynch, once commented that getting things right six out of ten times means you’re good in this business.
Try that in any other profession!
This margin for error might be especially wide with dividend growth investing, which is a long-term investment strategy that entails buying and holding shares in high-quality businesses paying safe, growing dividends to shareholders.
It’s hard to go wrong with this strategy, largely because it tends to funnel investors right into terrific businesses.
You can see what I mean by pulling up the Dividend Champions, Contenders, and Challengers list.
This list has curated data on hundreds of US-listed stocks that have increased dividends each year for at least the last five consecutive years.
As you might surmise, it takes a lot in order to generate the ever-larger profit necessary to sustain ever-bigger dividend payouts.
And even if you get some wrong along the way, the ones you get right could compound into giant sums and dwarf the mistakes.
I’ve used this strategy personally over the last 15+ years.
It enabled me to build the FIRE Fund.
That’s my real-money portfolio, and it generates enough five-figure passive dividend income for me to live off of.
It also enabled me to become financially independent and retire in my early 30s.
While getting the businesses you invest in right is good (although mistakes are inevitable and can be made up for), accounting for valuation at the time of making any investment is also extremely important.
Price is simply what you pay, but value is 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.
Even after making plenty of mistakes along the way, it’s hard to not achieve financial independence over time if one is sensibly acquiring undervalued high-quality dividend growth stocks regularly.
By the way, being sensible as it pertains to valuation is easier than it seems.
Fellow contributor Dave Van Knapp’s Lesson 11: Valuation, which is part of a series of “lessons” designed to teach dividend growth investing, dispels myths around valuation and makes the entire concept very easy to understand and apply on your 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…
Yum! Brands, Inc. (YUM)
Yum! Brands, Inc. (YUM) is an American multinational quick-service restaurant corporation.
Founded in 1997 under its current form, but with corporate history tracing its roots back to the 1970s, Yum! Brands is now a $38 billion (by market cap) QSR giant employing nearly 50,000 people.
After selling its Pizza Hut business in 2026 for a combined $2.7 billion (exiting a very competitive space where it lacked leadership), Yum! Brands operates three brands: Habit Burger Grill, KFC, and Taco Bell.
Yum! Brands has more than 40,000 restaurants worldwide.
The KFC and Taco Bell brands each account for roughly 40% of companywide sales, making them both very important to Yum! Brands.
An overwhelming percentage of its restaurants are franchised (about 98%), meaning Yum! Brands is mainly an asset-light, capital-light generator of franchise fees.
And those fees are coming from steady QSR business that provides a very basic value proposition to consumers.
People have to eat.
It’s survival 101.
And procuring food in a cost-effective, time-efficient manner in this day and age can sometimes be difficult, leading to lots of consumers choosing QSRs when the moments come to consume calories.
Moreover, many of these foods have built-in extra demand based on taste.
Taco Bell may not be the healthiest option out there (to put it gently), but tastebuds often win out.
Since Yum! Brands actually operates almost none of its restaurants, it’s able to generate recurring, visible, high-margin revenue from operators who must pay the parent company for the rights to operate these franchised stores.
Because Yum! Brands has built a fee-based model on top of popular foods that must be repurchased once consumed, it’s practically a money machine.
It puts up consistent growth across its revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Yum! Brands has increased its dividend for nine consecutive years.
Its five-year dividend growth rate is 8.6%, which is very solid and easily exceeds inflation.
And that high-single-digit dividend growth comes on top of the stock’s market-beating 2.2% yield.
That yield, by the way, is 40 basis points higher than its five-year average.
The payout ratio is sitting at just 37.8%, so Yum! Brands has a very healthy dividend poised for more growth ahead.
Hard to find obvious fault with any of this.
It’s a balanced dividend profile, with a good yield, fairly brisk dividend growth, and a high degree of safety.
Revenue and Earnings Growth
As much as that may be, though, this profile is largely seen through the lens of the past.
However, investors must always be focused on the future, as the capital of today ultimately gets risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will be useful when the time comes later to estimate fair value.
I’ll first show you what the business has done over the last ten years 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 create a pathway for envisioning where the business could be going from here.
Yum! Brands raised its revenue from $6.4 billion in FY 2016 to $8.2 billion in FY 2025.
That’s a compound annual growth rate of 2.8%.
While that seems mediocre at first glance, a lot of this comes down to the fact that Yum! Brands spun out its China business in 2016, which severely cut the revenue base.
More recently, as touched on earlier, the company sold off its Pizza Hut business, so it’s challenging to get a feel for what the business can do with more focus on just Taco Bell and KFC on a go-forward basis.
Meanwhile, adjusted earnings per share rose from $2.45 to $6.05 over this period, which is a CAGR of 10.6%.
That’s rather strong.
Notably, I used adjusted EPS due the moving parts I just outlined.
I think this 10%+ mark is a more accurate reflection of what Yum! Brands is actually capable of.
The bottom-line growth was aided by significant share buybacks, with the company reducing its outstanding share count by 30% over the past decade.
Looking forward, CFRA sees Yum! Brands compounding its EPS at a low-double-digit rate over the near term.
CFRA forecasts 12% YOY EPS growth in FY 2026 and 11% YOY EPS growth in FY 2027.
While the Pizza Hut divestiture further reduces the sales base, the company has already announced that the proceeds will directly fund a $4 billion buyback program – more than 10% of the company’s entire market cap.
And Pizza Hut had been struggling in the US for years, so Yum! Brands clearly cut the weakest part of the collection.
For its part, Yum! Brands most recently reported 12% YOY adjusted EPS growth for Q2 and is currently pacing a 14% YOY gain in adjusted EPS for this full year.
From everything I’m seeing, it appears that Yum! Brands is clearly tracking for more low-double-digit EPS growth over the foreseeable future.
And that sets the dividend up for at least high-single-digit growth.
It’s basically a continuation of the status quo, and the status quo has been quite good.
Financial Position
Moving over to the balance sheet, Yum Brands has a decent financial position.
The long-term debt/equity ratio is N/A due to negative common equity (stemming from the buybacks), but the interest coverage ratio is approximately 5.
That interest coverage ratio is kind of a minimum floor for me; any lower than this would make me concerned.
Yum! Brands has about $12 billion in long-term debt.
While that’s not necessarily egregious for a company of its size, it does show us a rather leveraged balance sheet.
Moreover, Yum! Brands has a speculative-grade BB+ credit rating from S&P.
That kind of credit rating is referred to as “junk”.
The balance sheet strikes me as easily the worst part of the whole business.
Profitability is excellent.
Although ROE is N/A due to the common equity issue, net margin has averaged 20.9% over the last five years.
Also, ROIC is routinely north of 40%, which is outstanding.
Other than the balance sheet, which could stand serious improvement, the core business looks great.
And with economies of scale, brand recognition, some pricing power, a heavy franchise model that ensures steady revenue, and entrenched mindshare among consumers, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
The QSR space, in particular, is extremely competitive, although regulation and litigation are lesser risks.
Usage of GLP-1 weight-loss drugs are a rising risk, as these drugs can lead to less appetite for the types of foods that Yum! Brands provides.
The company is exposed to volatile input costs, labor, exchange rates, and geopolitics.
I view the balance sheet as a risk, as Yum! Brands is more leveraged than I’d expect it to be.
Any kind of major economic slowdown would likely negatively impact the company, although the fact that it sells foods at low nominal price points helps to insulate it somewhat, as does the fact that it’s heavily franchised.
This doesn’t look like a high-risk business model to me.
But the valuation, which is more attractive than usual after a near-20% pullback, seems to price in more risk than what exists…
Valuation
The P/E ratio has dropped to 21.5.
For a business reliably posting double-digit growth, that’s not all that high.
It’s well below its five-year average of 25.7.
The cash flow multiple of 17.7 is also far lower than its five-year average of 22.5.
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 8%.
This growth rate is at the high end of what I usually allow for, but it seems warranted here.
I’m extrapolating out something lower than the demonstrated five-year dividend growth rate.
And with Yum! Brands posting double-digit EPS growth and expected to continue doing so, that easily sets the table for high-single-digit dividend growth.
Unless there’s a sudden collapse in the company’s earnings, I don’t see anything to indicate how or why this kind of dividend growth won’t materialize.
The DDM analysis gives me a fair value of $162.00.
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.
My viewpoint is that this stock recently dropped from fair value to 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 YUM as a 4-star stock, with a fair value estimate of $155.00.
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 YUM as a 5-star “STRONG BUY”, with a 12-month target price of $173.00.
I’m right in the middle. Averaging the three numbers out gives us a final valuation of $163.33, which would indicate the stock is possibly 16% undervalued.
Bottom line: Yum! Brands, Inc. (YUM) is a great business with two of the best QSR brands in the world. Steady franchise fees. Very high returns on capital. Other than the balance sheet, there’s very little to nitpick. With a market-beating yield, a low payout ratio, high-single-digit dividend growth, nearly 10 consecutive years of dividend increases, and the potential that shares are 16% undervalued, long-term dividend growth investors interested in the QSR space have a compelling opportunity on their hands after this stock’s recent ~20% drop.
-Jason Fieber
Note from D&I: How safe is YUM‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 50. 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, YUM’s dividend appears Borderline 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.
Disclosure: I have no position in YUM.
