I’m sitting here at noon in the middle of the week at a Starbucks (a business I own a slice of), writing this article.
I’m surrounded by folks that are probably, on average, 30 years older than me.
This is due in part to the fact that I live in Southwest Florida, a popular spot for retirees.
But it’s not lost on me that most people my age don’t have time to relax at a Starbucks at noon on a Wednesday because they’re busy hustling and bustling away at their jobs.
[ad#Google Adsense 336×280-IA]Indeed, it’s the ability to do what I want, when I want, with whom I want that drove me to become financially independent at a young age.
And being the focused and driven person I am, I went from below broke in my late 20s to essentially retired in my early 30s.
It wasn’t easy. But nothing worth having ever is.
However, I can say that the hard work was all worth it.
The surprising thing is that just about anyone can do what I did.
As such, it sometimes boggles my mind that more people aren’t retired in their 30s or 40s.
It seems silly to me that people in their 60s and 70s have a monopoly on retirement.
But it doesn’t have to be like that.
I simply lived below my means.
And then I invested my excess capital in high-quality dividend growth stocks like those you’ll find on David Fish’s Dividend Champions, Contenders, and Challengers list.
Mr. Fish has compiled data on almost 800 US-listed stocks that have all increased their dividends for at least the last five consecutive years.
I invest in high-quality dividend growth stocks because growing dividends tend to be a great initial litmus test for the quality of a business.
After all, it’s incredibly difficult to write ever-larger checks to shareholders for years or decades on end without the underlying supporting growth of profit to support those checks.
Moreover, the growing dividends serve as a great source of passive income.
I don’t have to lift a finger to collect my dividends. They come in automatically. As long as I continue holding my shares, the dividends roll in like clockwork.
And the dividend increases work out like “pay raises” that I don’t have to work for.
A lot of people bust their butts for 5% raises at work.
But I get 7% pay raises for doing nothing.
It’s more for less. And it’s wonderful.
This recipe of hard work, living below my means, and investing in great businesses that reward me with growing dividends has resulted in the real-life, real-money six-figure portfolio that’s on pace to spit out more than $11,000 in dividend income this year.
Of course, I’m not just buying dividend growth stocks randomly.
Every stock I invest in undergoes a rigorous quantitative and qualitative analysis. And that’s only after I find a business that’s in my circle of competence.
But just as important, each and every stock also undergoes a process of valuation before I invest, as I want to make sure that a dividend growth stock is undervalued before I buy.
See, price is what you pay, but value is what you’re getting for your money.
Knowing the price of a stock tells you very little. Knowing value, however, tells you what that stock is worth. And it’s value that gives context to price.
This works pretty much the same with anything else in life.
You don’t go around buying things for any price. You have a general idea of what something is worth. And you try to pay as far below that estimated worth as possible.
Well, the same goes for stocks.
Except the benefits are perhaps even more tangible.
An undervalued stock will generally offer a higher yield, greater long-term total return prospects, and less risk.
This is all relative to what would otherwise be available if the same stock were fairly valued or overvalued.
It’s easy to see how this works.
Price and yield are inversely correlated. All else equal, a lower price will equal a higher yield.
That higher yield means more income in an investor’s pocket today… and potentially for the life of the investment.
In addition, that higher yield positively impacts total return, as yield is a major component of total return.
Meanwhile, capital gain, the other component, is also positively impacted by virtue of the upside that exists between the lower price paid and the higher worth of the stock.
This all works in an investor’s favor when thinking about risk, too.
That’s because a margin of safety is built when the price paid for a stock is well below the intrinsic value.
A margin of safety is basically a buffer between the price paid and the intrinsic value of a stock.
That means if a business doesn’t perform as expected or does something wrong, you have a cushion.
When a margin of safety is introduced, the value of a business would have to drop precipitously before the investment is upside down.
With all of this known, I’m always on the lookout for a high-quality dividend growth stock priced below what it’s worth.
Well, I think a prominent dividend growth stock is undervalued right now…
VF Corp. (VFC) is an apparel and footwear company that designs and manufactures or sources from independent contractors a variety of clothing including jeans, sportswear, outerwear, luggage, and footwear.
VF Corp. is a pretty amazing company, as I’ll show by the end of this article.
While an economic moat is pretty difficult to build in the apparel industry, VF Corp. has done a tremendous job building out its competitive advantages.
Those competitive advantages are largely tied to their brands.
Their premium lifestyle brands include The North Face, Timberland, Nautica, and Vans.
And then they also offer well-known value brands like Lee and Wranglers.
So VF Corp. is super interesting in that they have great options across the apparel spectrum.
They have their individual Imagewear, Jeanswear, Sportwear, and Outdoor & Action Sports offerings, and they offer apparel across many different price points.
And it’s these diverse, well-known, and high-quality brands that have helped VF Corp. grow tremendously over the last decade.
As a dividend growth investor, however, it’s the growth of a company’s dividend that really piques my interest.
Well, the company doesn’t disappoint here.
First, consider that they’ve increased their dividend for 44 consecutive years.
That’s impressive no matter the business or industry.
But I think it’s even more impressive when you consider the fact that the apparel industry is constantly having to adjust for changes in fashion and trends. Fashion may change, but VF Corp.’s dividend is only moving in one direction: up.
If the length of their dividend growth track record doesn’t already impress enough, know that the company has increased its dividend at an annual rate of 12.2% over the last decade.
So it’s not just clockwork growth but sizable clockwork growth.
And with a payout ratio of 58.3%, there’s still room for plenty more dividend raises for years to come.
Although that payout ratio is a bit higher than I’d like to see (I consider a 50% payout ratio “perfect”), it’s not a concern whatsoever.
Lastly, the stock offers a very appealing yield of 3.20% right now.
That’s quite high no matter how you slice it.
It’s much higher than the broader market. It’s far better than what you’ll get at your bank. And it’s also more than 100 basis points higher than the stock’s own five-year average yield.
I already mentioned earlier how undervaluation tends to positively influence yield and total return.
Well, now you see the dots connecting.
The dividend pedigree is there. I mean, this stock checks all the boxes for the dividend.
You’ve got decades of dividend growth, a high yield, an outstanding dividend growth rate, and a moderate payout ratio.
But in order to have a better idea of what kind of dividend growth to expect moving forward, we must first know what kind of underlying growth the company is generating.
So we’ll first look at what VF Corp. has done over the last decade in terms of top-line and bottom-line growth.
And then we’ll compare that to a near-term forecast for EPS growth.
Combined, this will give us a pretty solid idea of what kind of profit growth VF Corp. should manage going forward, which will help us determine what kind of dividend growth to expect.
From fiscal years 2007 to 2016, revenue grew from $7.219 billion to $12.019 billion. That’s a compound annual growth rate of 5.83%.
Earnings per share increased from $1.30 to $2.54 over this period, which is a CAGR of 7.73%.
A combination of share buybacks (outstanding shares are down by about 6% over the last decade) and margin expansion is the reason for the excess bottom-line growth.
Pretty solid stuff here. It’s a fairly large apparel company growing at almost 8%. And the growth has been almost completely secular – like clockwork.
Moving forward, S&P Capital IQ believes VF Corp. will compound its EPS at an annual rate of 10% over the next three years, which would indicate some growth acceleration. Retail expansion, e-commerce growth, and share repurchases are all cited as reasoning for this.
While 10% EPS growth might be a tough target to hit, VF Corp. doesn’t really need to do that to be a great investment here. Even just continuing with ~8% EPS growth would allow like dividend growth. When combined with the ~3.2% yield, that’s a pretty appealing income/growth picture.
The rest of the company’s fundamentals are just as high quality as the growth.
With a long-term debt/equity ratio of 0.41 and an interest coverage ratio over 17, the balance sheet is excellent condition.
Profitability is also outstanding.
Over the last five years, VF Corp. has averaged net margin of 9.69% and return on equity of 21%.
These numbers are competitive with apparel companies that focus far more on premium brands. Moreover, net margin has expanded nicely over the last decade.
All in all, I think there’s a lot to like about VF Corp.
The dividend pedigree, as shown, is top-notch. You just can’t ask for much more, especially in this industry.
And the rest of the fundamentals definitely hold up.
Meanwhile, the business is super easy to understand.
Warren Buffett talks all the time about investing in businesses within your circle of competence.
Well, I’m not sure it gets much easier to understand than clothing. There’s a basic need for jeans, jackets, and backpacks. VF Corp. fills that role very, very nicely.
Although e-commerce is a looming threat for many traditional companies that rely on traditional retail, VF Corp. has maneuvered its direct-to-consumer sales into a formidable aspect of the company.
For the most recent quarter, DTC business grew 11% YOY. DTC business accounted for 37% of Q4 2016 revenue, which is considerable.
What’s interesting, though, is that the stock is down over 10% over the last year.
And I think that’s led to an opportunity. The stock now looks quite undervalued…
The P/E ratio is sitting at 18.83 right now. That compares extremely favorably to the five-year average P/E ratio of 22 for this stock. Furthermore, investors are paying less for the company’s cash flow, sales, and book value than they typically have, on average, over the last five years. Plus, the current yield, as noted earlier, is substantially higher than its own five-year average.
So the stock does look cheap. But how undervalued might it be? What’s a good estimate of its fair value?
I valued the stock using a dividend discount model analysis. I assumed a 10% discount rate. And I factored in a long-term dividend growth rate of 8%. I think that growth assumption makes sense when you look at the moderate payout ratio, 12% long-term dividend growth, ~8% long-term EPS growth, and 10% near-term EPS growth forecast. The DDM analysis gives me a fair value of $90.72.
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.
[ad#Google Adsense 336×280-IA]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 is very cheap right now.
The margin of safety present looks to be significant.
But the good news is that I’m not the only one looking at this stock and its valuation.
So you don’t have to take just my word for it.
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 VFC as a 4-star stock, with a fair value estimate of $70.00.
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 VFC as a 3-star “HOLD”, with a fair value calculation of $51.60.
So we’ve got three disparate numbers here. That’s why I like to average them out as we conclude the article: I’m able to get a distilled valuation from three different valuation systems. That final valuation for VFC is $70.77, which is right about where Morningstar landed. That would indicate this stock is possibly 35% undervalued right now.
Bottom line: VF Corp. (VFC) is a prototypical dividend growth stock, with an amazing track record of managing the ups and downs of the apparel industry. More than four straight decades of dividend increases bears that out. The fundamentals are excellent, and the company retains competitive advantages through its superior brands. With the potential for 35% upside on top of a yield that’s well above its recent historical average, there could be a huge opportunity for long-term dividend growth investors here.
— Jason Fieber
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