It’s your moment.
Yes. Right now. This second.
Here’s another moment.
In fact, you’ve already had a few moments just in the time it’s taken you to read this.
Every second is a moment of opportunity.
And the last thing you’ll want to do is squander those moments.
You’ll instead develop this attitude where you have an unyielding passion to take advantage of every second.
See, time is the great equalizer in this world.
We’re all given the same 24-hour period with which to do and live as we please.
One could use that time to accomplish amazing things. And one could, of course, waste the time away.
How one approaches this is what separates the wheat from the chaff. How you use your time will determine how successful (or unsuccessful) you’ll be.
I’ve experienced both sides of that coin.
For years, I wasted my moments of opportunity.
And the end result was finding myself flat broke in my late 20s, back in late 2009.
But as long as we’re alive and breathing, we’re given new moments of opportunity. This can allow us to right past wrongs, using our new seconds to do amazing things.
Adopting this attitude allowed me to turn my life around by working hard, saving the majority of my income, and intelligently investing my capital into wonderful businesses that reward me with growing dividend payments.
I’m talking businesses like those that can be found on David Fish’s Dividend Champions, Contenders, and Challengers list, which is a compilation of more than 800 US-listed stocks that have paid out rising dividend payments for at least the last five consecutive years.
As a result of that saving and investing, I now own and control a six-figure dividend growth stock portfolio that’s chock-full of some of the best businesses in the world.
And being great businesses, they earn a ton of profit.
In fact, they earn so much that they often can’t possibly efficiently reinvest this money, so they return a good chunk of that profit directly back to their shareholders.
These are dividend payments. Cash money, baby.
As the profit grows, so do those dividend payments.
The five-figure and growing passive dividend income this portfolio generates for me has rendered me financially independent, which means I can generally go about my life as I please.
This life turnaround only took a few years to complete, which just goes to show how powerful the right attitude can be. Making the right choices and taking advantage of every moment can deliver amazing results.
One right choice I know I made was settling on dividend growth investing as the investment strategy to deliver me wealth, passive income, and financial independence, all within a pretty short period of time.
As I just noted, I invest in great businesses that reward their shareholders with growing dividend payments.
These growing dividend payments are the “proof in the profit pudding”.
Don’t tell me that you’re earning and growing profit. Show me.
The growing dividends keep companies honest. Rising dividend payments can serve as a great litmus test of business quality, and they show that management values the shareholders.
Furthermore, and perhaps most salient, these growing dividend payments can fund an entire lifestyle, allowing one to make even more of their ongoing moments, due to the additional freedom they have over their time and choices.
And that’s what today’s article is all about, as I’m going to highlight a high-quality dividend growth stock that appears to be undervalued right now.
This could be your chance to make the most of this moment.
That’s because while dividend growth investing is a great strategy that I’m a huge proponent of (due to real-life results that have benefited me so strongly), one cannot approach it blindly.
You can’t just buy dividend growth stocks randomly.
One has to approach investing intelligently, with a long-term mindset that prioritizes fundamental and qualitative analysis, risk management, and sound valuation practices.
It’s that last part that’s particularly relevant to today’s piece.
Price is what you’ll pay for something. But value is what something is worth.
If you’re able to invest in a high-quality dividend growth stock when its price is well below its estimated intrinsic value, you’re setting yourself for extraordinary investment results over the long run.
Undervaluation can confer a number of benefits to the long-term dividend growth investor.
An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and less risk.
These dynamics are relative to what the same stock might otherwise offer 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.
This higher yield will likely mean more income in your pocket both now and later, as it’s just more investment income on your investment.
But the higher yield will also likely positively affect total return, giving way to greater long-term total return potential.
That’s because total return is comprised of two components: income (dividends/distributions) and capital gain.
The former is obviously given a boost right away when a lower price results in a higher yield.
But the latter is also possibly given a boost via the “upside” that exists between a lower price and higher intrinsic value.
If a stock that’s deemed to be worth $100 is priced at $75, there’s $25 worth of upside that could be captured if/when the stock market more correctly prices the stock.
The stock market isn’t necessarily great at appropriately pricing stocks, meaning price and value don’t often (or perhaps ever) necessarily reflect each other exactly.
Sometimes stocks are too expensive. And sometimes they’re clearly cheap.
Cheapness or expensiveness is based on the relationship between price and value.
But if you’re able to invest when the “cheap” situation is clear, this results in extra total return potential via the upside.
And that upside is on top of whatever organic upside is naturally available as a business makes more money and becomes worth more (increasing its intrinsic value in the process).
This all has a way of reducing risk, too.
That’s because a margin of safety should be present when price is well below value.
Just in case something goes wrong with a business, or just in case your intrinsic value estimate is too liberal, you want to buy when you have an advantageous buffer between price and value.
If you pay $100 for a stock with an estimated intrinsic value of $100, you have no wiggle room.
But if you pay $75 for that same stock, you have a margin of safety that protects your downside. And this is while simultaneously experiencing the other benefits I just laid out.
With all of this in mind, buying a high-quality dividend growth stock when it’s undervalued can be an excellent way to use a moment of opportunity correctly.
And the great news is that estimating intrinsic value doesn’t require some kind of voodoo magic.
Fellow contributor Dave Van Knapp laid out an excellent valuation methodology for dividend growth stocks via his “lesson” on valuation, which is part of an overarching series of lessons on the dividend growth investment strategy as a whole.
So let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
PPL Corp. (PPL) is an energy and utility holding company that, through its subsidiaries, generates and markets electricity in the northeastern and western US and delivers electricity in Pennsylvania and the UK.
It operates in the following segments: Kentucky Regulated, 42% of fiscal year 2016 revenue; UK Regulated, 29%; Pennsylvania Regulated, 29%.
The company has more than 10 million customers across its service areas.
Investing in products and/or services that are necessary and/or ubiquitous is my bread and butter.
That’s because when I think about collecting a sustainable and growing dividend, a growing dividend that is funded on the back of growing profit from selling necessary/ubiquitous products and/or services, is a dividend that is highly likely to flow and grow.
Well, it doesn’t get much more necessary and ubiquitous than electricity.
As such, utilities often form a bedrock for many dividend growth investors’ portfolios.
Many utility companies have dividend histories dating back many decades, and the odds that many of these same utilities will continue to pay growing dividends moving forward appear to be quite strong.
PPL, with a dividend history dating back to at least the 1940s, is a good example of this.
The dividend growth track record currently stands at 16 consecutive years.
And with management routinely citing the importance of and dedication to growing its dividend, this streak should continue for years to come.
In fact, dividend growth was addressed in the company’s most recent (Q3 2017) quarterly earnings release: “In addition, the company continues to target dividend growth of about 4 percent a year through 2020.”
That 4% annual dividend growth target would be in line with recent dividend increases.
Plus, it would be a slight acceleration off of the 10-year dividend growth rate of 3.3%.
But even if they fall a bit short of that 4% mark, consider that the stock is yielding 5.11% right now.
So it doesn’t take much dividend growth to make this an appealing idea from the standpoint of aggregate passive dividend income over both short and longer periods of time.
That yield is well in excess of the broader market, as one would expect from a slower-growing utility stock.
But what’s really impressive is the fact that the yield much higher than the industry average, and it’s also more than 50 basis points higher than the stock’s own five-year average yield.
The earlier point made about undervaluation and a higher yield is playing out here.
One thing to keep in mind, though, is that the payout ratio, at 71.5%, is elevated.
But an elevated payout ratio is not uncommon for a utility stock.
The big dividend is obviously pretty appealing, but we also need to have an estimate of what kind of dividend growth to expect moving forward.
While a 5%+ yield looks great now, that income could be slowly eaten away by inflation if it’s not growing.
So we’ll next take a look at what kind of growth we might expect from PPL moving forward.
This forward-looking expectation is going to be built off of a combination of past long-term (using 10 years as a proxy for the long haul) growth and a professional forecast of near-term bottom-line growth.
Blending the past and a forecast for the future in this manner should give us a reasonable idea of what PPL might deliver in terms of dividend growth over the foreseeable future, which will also help us value the business and its stock.
PPL has grown its revenue from $6.498 billion to $7.517 billion from fiscal year 2007 to fiscal year 2016. That’s a compound annual growth rate of 1.63%.
This revenue growth is neither impressive nor unimpressive for a large utility over this period, although PPL’s revenue growth was “lumpy” in the sense that it spiked up and dropped back down to due a combination of factors: the 2011 acquisition of the Central Networks electricity distribution business in the UK, the 2015 spin-off of its competitive energy business, and the significant devaluation of the pound.
Meanwhile, the bottom line shows us earnings per share that slightly declined from $3.35 to $2.79 over this period.
While most utilities offer a straightforward business model that tends to grow smoothly but slowly, PPL is a bit more complicated with its geographical footprint and the multiple large-scale changes that have occurred over the last decade.
That said, at its core, this is still a utility company. Now that much of the business shaping has already transpired, results should be more smooth in the future.
I usually use CFRA’s three-year forecast for compound annual EPS growth, but CFRA does not provide a number for PPL.
In lieu of that, PPL’s Q3 earnings release has this to say about near-term EPS growth: “The company reaffirmed expectations for 5 to 6 percent compound annual earnings growth per share from 2017 through 2020, measured against its original 2017 ongoing earnings forecast midpoint of $2.15 per share.”
Looking at the company’s balance sheet, we see plenty of debt. But the leverage is in line for the industry, in my view. Many large domestic utilities have balance sheets that are similar to what PPL operates with.
The company’s long-term debt/equity ratio stands at 1.80, while the interest coverage ratio is just under 4.
Profitability is just as good as, if not better than, its peers. The fundamentals here are rather robust.
Over the last five years, the company has averaged net margin of 14.23. Return on equity averaged 12.48% over this same period.
Reported net margin and ROE was volatile on an annual basis over the last five years, due to some of the aforementioned reasons, but the long-term averages are strong.
Not many utilities are offering a yield of over 5% right now, as many utility stocks look quite overvalued right now. Income-hungry investors have chased yield in an environment with low rates, which has pushed up utility stocks.
This stock, though, has suffered a 17% drop over the last six months, much of which appears due to the company’s exposure to UK. With Brexit, a weakening pound, and the potential of price capping in the UK.
However, it’s important to note that PPL only provides transmission – not generation – in the UK.
That said, there are still risks with investing in any utility business.
Namely, there is regulation, rising interest rates, and the ongoing shift to cleaner energy sources.
But I think this particular utility stock is one of the best values in the entire sector…
The P/E ratio is sitting at 13.9 right now, which favorably compares to the stock’s five-year average P/E ratio of 15.4. That’s also obviously well below where the broader market is at (as a utility stock’s valuation should be).
Meanwhile, both the price-to-book ratio and the price-to-cash flow ratio are both below their respective recent historical averages – and that’s in a market that has pushed utility stocks to sky-high valuations.
And the yield, as noted earlier, is quite a bit higher than its five-year average, meaning investors buying this stock today are “locking in” a yield much higher than what they otherwise could have, on average, over the last five years. Plus, the company is due to announce a dividend increase within the next month, which makes this income picture even more attractive.
So the stock does look relatively cheap, against both the broader market and most other utility stocks in general. But what might a reasonable estimate of its intrinsic value be?
I valued shares using a dividend discount model analysis.
I factored in an 8% discount rate (to account for the high yield) and a long-term dividend growth rate of 3.25%.
This long-term DGR is, in my opinion, conservative. It’s below the company’s demonstrated long-term dividend growth, and it’s also 75 basis points lower than what the company is guiding for over the foreseeable future.
And the company’s recent volatility in operating results leads me to believe a lower number is better here.
The DDM analysis gives me a fair value of $34.34.
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.
The stock looks to be at least modestly undervalued right now, and this is before factoring in what’s surely going to be a dividend increase in the next 30 days or so. But my perspective and valuation isn’t the only one that exists for this stock, so let’s see what two professional analysis firms think about this stock and its valuation.
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 PPL as a 4-star stock, with a fair value estimate of $37.00.
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 PPL as a 4-star “BUY”, with a fair value calculation of $30.16.
I came out somewhere in the middle, but I think it’s worth noting that the latter firm has a 12-month target price of $41 on the stock. Nonetheless, averaging out these three numbers gives us a final valuation of $33.83, which would indicate the stock is potentially 9% undervalued right now.
Bottom line: PPL Corp. (PPL) is a company providing a necessary and ubiquitous service to millions of people. A dividend track record dating back decades, a yield of over 5%, a management team that’s dedicated to dividend growth, an upcoming dividend raise, and the potential for 9% upside all add up to a pretty compelling idea in an industry that doesn’t offer a lot of value. This could be your moment to take advantage of a long-term dividend growth stock investment opportunity.
— Jason Fieber
Note from DTA: How safe is PPL’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 80. 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, PPL’s dividend appears to be safer than the average company’s. Learn more about Dividend Safety Scores here.
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