It’s often difficult to know whether or not you have a real “deal” on your hands.
I’ll sometimes see an advertisement for merchandise that’s “50% off”.
But if the merchandise was far too expensive in the first place, is a 50% sale really a good deal?
Said another way, something being marked down from $100 to $50 isn’t a good deal at all if that something is only worth $40.
[ad#Google Adsense 336×280-IA]This is why it’s so important to remain vigilant as it pertains to deciphering the intrinsic value of things in life, knowing that value is far more pertinent information than price.
And it’s never more important to be vigilant than when dealing with stocks.
One can see the price of stocks change every second of every trading day.
A stock might be $40.05 in the morning, then $39.22 in the afternoon.
This can happen even if nothing at all changed in terms of the value of the stock.
In fact, that’s how it usually is.
The value of a business generally changes rather slowly, like a glacier moving. But the price can (and often does) change quickly.
That’s why today’s article should be of special interest.
I’m going to discuss a high-quality dividend growth stock that appears to right now be priced below its intrinsic value.
The reason I’m picking a dividend growth stock is because dividend growth stocks tend to be fantastic long-term investments.
Numerous studies show that they outperform the broader market over long periods of time.
But even more important, the dividend income shareholders receive from holding these stocks is tangible passive income. Better yet, it tends to regularly grow organically (all by itself) year in and year out as the underlying business operations support higher profits which beget bigger dividends.
In fact, I’m such a believer in these stocks that I’ve bet my own early retirement on them: the six-figure portfolio I’ve built over the last six years with my hard-earned savings is chock-full of these stocks, and I’m now receiving growing dividend income in the five figures.
You can also find more than 700 of these stocks via David Fish’s Dividend Champions, Contenders, and Challengers list.
But as much as I love these stocks, I love them even more when they’re undervalued (priced less than they’re worth).
Dividend income is great. But more is better, right?
That’s one of the primary reasons one wants to invest in these stocks – regular dividend raises means the passive income a shareholder receives is growing.
Well, a higher yield means the amount of income you initially “lock in” on your investment is more than it would be if the yield were lower.
Price and yield are inversely correlated, all else equal.
So that means a cheaper stock will almost always come with a higher yield (assuming no change to the dividend).
As such, a major reason to be aware of valuation and buy undervalued high-quality dividend growth stocks is because the yield will likely be higher, meaning both your current dividend income and long-term aggregate dividend income will likely be far greater.
The dividend growth itself is also positively impacted when you pay less, locking in that higher yield, because the dividend growth is coming off of a larger base.
Of course, yield being a major component to total return, one’s long-term total return should be higher when paying less, and that’s before factoring in any additional upside that exists between the lower price you paid and what the stock is actually worth.
And this all works in your favor to lower your risk.
After all, paying $50 for something worth $40 is far riskier than paying $30 for that same something.
That’s certainly true on the face of it, but it’s even more blatant when you’re looking at all of the ancillary benefits that exist when snagging undervalued dividend growth stocks.
Fortunately, there are a number of tools that exist that are designed to help investors determine a reasonable estimate of fair value for just about any dividend growth stock out there.
One such resource is available right here on the site.
Put together by fellow colleague Dave Van Knapp, it’s one of his dividend growth investing lessons that are meant to help everyday investors maximize their long-term potential and income.
So we’re now going to take a closer look at a dividend growth stock from Mr. Fish’s aforementioned list that right now appears to be undervalued, leading to all of those great benefits.
Ameriprise Financial, Inc. (AMP) is a holding company that, through its subsidiaries, offers a range of financial products and services to clients, including asset management and insurance. They have more than $750 billion in assets under management.
This company doesn’t have the lengthy corporate pedigree that many other companies I track and invest in do, and so it also lacks a dividend growth streak that stretches back decades.
That’s because Ameriprise Financial was spun off from former parent company American Express Company (AXP) back in 2005.
However, Ameriprise has carved out a really solid business all by itself, and it’s been increasing its dividend for as long as it possibly could have.
With 11 consecutive years of dividend increases, we can see that Ameriprise has been growing its dividend since initiating its payout as an independent company.
If that’s not a clear penchant for paying a dividend and increasing it at every opportunity, I’m not sure what is.
And not surprisingly, the company has grown its dividend aggressively since initiating it.
I say that’s not surprising because a payout ratio obviously starts out at 0% before a dividend is initiated. So a dividend can be aggressively increased even without strong underlying profit growth due to the breathing room there.
That breathing room has translated into a 10-year dividend growth rate of 37.1%.
Now, that’s highly unlikely to continue. Much of that was due to the expansion of the payout ratio, coming off of 0% at the outset.
Indeed, the most recent dividend increase was about half that long-term average, though still impressive at over 15%.
And with a payout ratio of just 31.6%, there appears to be plenty of room left to continue expanding that dividend over the foreseeable future, even absent real strong profit growth.
That’s all on top of a yield of 2.85%, which is obviously appealing in the sense that’s well in excess of the broader market.
Plus, the company is due for a dividend increase in the coming weeks.
Moreover, that’s more than 80 basis points higher than the stock’s five-year average yield of 2%.
Yield is tough to come by in this environment, yet you have a stock here that’s offering a yield that’s substantially higher than what it typically has offered, on average, over the last five years. That’s notable, in my view.
While the dividend metrics are really, really solid, a dividend’s sustainability and growth is only as good as the underlying business’s ability to produce the necessary profit and growth of that profit.
As such, we’ll take a look at what kind of growth the company has generated across the top and bottom lines over the last decade.
How does Ameriprise score here?
Pretty good, all considered.
The company’s revenue is up from $8.140 billion in fiscal year 2006 to $12.200 billion in FY 2015. That’s a compound annual growth rate of 4.60%.
A couple factors to consider here.
First, the financial crisis decimated the results for many financial firms, and Ameriprise wasn’t totally immune – revenue dropped markedly in FY 2008.
But some of those headwinds were countered by the company’s acquisition of Columbia Asset Management in 2010, which doubled the assets under management for Ameriprise.
This had a tremendous positive effect on the business, as the company dramatically increased its exposure to wealth management just as the economy and stock market started to recover. The transaction thus turned out to be quite accretive.
The acquisition also simultaneously increased the company’s exposure to sticky assets and regular fees, putting them in a position to add value and offer multiple financial products under one roof.
That tailwind translated into impressive profitability expansion, which, when combined with an aggressive share buyback policy, helped juice the company’s bottom-line growth.
Earnings per share increased from $2.54 to $8.48 over this period, which is a CAGR of 14.33%.
Impressively, the outstanding share count is down by more than ¼ over the last 10 years.
They timed their move further away from insurance and toward wealth management well; however, this increased exposure to volatile assets also potentially means their underlying results will be more volatile, too. And that could have implications for the dividend and the growth of it.
Looking out over the next three years, S&P Capital IQ believes that Ameriprise will compound its EPS at an annual rate of 15%. That’s in line with what we see above, but keep in mind that the last six or so years has seen an epic bull run in the stock market, just as Ameriprise doubled its AUM. That could be difficult to repeat; any weakness in the markets could cause trouble for Ameriprise’s growth trajectory.
One area of this business that I believe could be improved is the balance sheet.
Ameriprise, like many other companies across most other industries, has loaded up on some cheap debt to retire expensive equity over the last decade (the huge buybacks mentioned above). Detractors of this strategy will surely point to the fact that the stock is down some 25% over the last year (which is why it now appears to be undervalued).
Although the amount of treasury stock on the balance sheet clouds their true leverage level, the long-term debt/equity ratio is still up to 1.42.
The company does carry a large amount of absolute long-term debt, and it’s a bit high relative to the market cap of the company. Overall, they’re more indebted than most peers I’ve been able to look at.
The interest coverage ratio, at over 6, is also a bit lower than what I’ve seen among some competitors.
Profitability, however, is robust. And I believe it’s been boosted by a well-timed bet on the doubling of AUM, along with the higher leverage.
Over the last five years, the firm has averaged net margin of 11.68% and return on equity of 15.31%.
The company’s track record out of the gate (after being spun off) has been really strong. Management obviously increased their exposure to wealth management at just the right time, at the cusp of one of the strongest bull markets in history.
However, prevailing headwinds are real.
First, asset management is becoming more and more tilted toward passive funds, reducing the amount of fees that managers can charge and the necessity for active managers in the first place.
Second, the domestic stock market is near an all-time high. It seems more and more likely that there will be a major correction at some point in the near future, which could drop AUM (depending on flows) and the fees associated with that.
But is the stock cheap enough to see through the risks? Is there a sizable margin of safety here?
The P/E ratio is 11.41, which is very favorable when compared to the five-year average P/E ratio of 14.4 for this stock. Most other basic valuation metrics are also favorable. And we saw above just how favorable the yield is right now relative to where it’s usually been, on average, over the last five years.
So it does seem cheap. But by how much? What’s a good estimate of the stock’s intrinsic fair value?
I valued shares using a dividend discount model analysis with a 10% discount rate and a 7.5% long-term dividend growth rate. That growth rate is on the higher end of what I normally account for, but I’m factoring in the low payout ratio, EPS forecast, and historical dividend growth rate. And I’m obviously including a sizable margin of safety there when looking at what Ameriprise has delivered over the last decade or so (to account for the risks). The DDM analysis gives me a fair value of $115.24.
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 believe we’re looking at a high-quality dividend growth stock trading for a price below what it’s worth. But am I the only one who believes that?
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 AMP as a 3-star stock, with a fair value estimate of $100.00.
S&P Capital IQ 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.
S&P Capital IQ rates AMP as a 3-star “hold”, with a fair value calculation of $102.10.
I came in on the high end, but I think the lower valuation estimates include an even larger margin of safety. But I like to average out these three valuation opinions so as to blend these different perspectives together into one number. I believe that increases the likelihood of accuracy. That final valuation is $105.78, meaning this stock is possibly 9% undervalued right now.
Bottom line: Ameriprise Financial, Inc. (AMP) has been an extremely strong performer since being spun off in 2005. A well-timed bet on asset management came at just the right time. Meanwhile, the stock is down some 25% over the last year, likely due to fears over the state (and future) of the industry. That has led to the potential for 9% upside on top of a yield that’s far higher than its recent historical average, and that’s before factoring in an upcoming dividend raise. This could be a rare deal in an otherwise expensive market.
— Jason Fieber
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