Over the years, I haven’t written much about energy stocks or the oil patch. But let’s take a look for a well-valued dividend growth stock in that sector, starting with this month’s selection for the Valuation Zone: ExxonMobil (XOM).

Measured by revenue, ExxonMobil is the 4th largest oil company in the world. Among publicly traded oil companies, it is the largest.

ExxonMobil is an integrated oil company, meaning that it is involved in exploration, oil and gas production, refining, and chemicals. It has operations around the world.

Quality Snapshot and Dividend Safety

Here is ExxonMobil’s Quality Snapshot. To create this, I use the following sources, which I have come to trust and respect over the years:

• Safety and Financial Strength grades from Value Line
• S&P’s Credit rating
• Morningstar’s Moat rating, and
• Simply Safe Dividends’ Dividend Safety grade.

As you can see, ExxonMobil is an extremely high-quality company. It gets top grades across the board, with the slight exception of Morningstar’s Moat rating, where it garners the 2nd-highest grade.

XOM’s credit rating is noteworthy. At AA+, it is just one notch below the highest grade a company can get, AAA. Only two companies in the world have AAA ratings (Microsoft and Johnson & Johnson).

ExxonMobil currently yields 4.2%, which I consider to be high-yield. Its recent dividend growth rate has been in the mid-single digits. Its dividend is considered to be very safe.

[Image source: Simply Safe Dividends]

ExxonMobil has raised its dividend for 36 straight years, which spans the past 3 recessions (shown by the gray bands on the following chart). Ignore the apparent dip in 2002, that is a data aberration.

ExxonMobil’s Valuation

To value a stock, I use four different methods, then average them out. For more details on my methodology, see Dividend Growth Investing Lesson 11: Valuation.

Step 1: FASTGraphs Default Valuation

In the the first step, we check the stock’s current price against FASTGraphs’ basic estimate of its fair value.

FASTGraphs compares the stock’s current price-to-earnings (P/E) ratio to the historical average P/E ratio of the whole stock market. That historical average is 15.

In Exxon’s case, FASTGraphs lowers the market-average P/E ratio, because Exxon’s growth has been slower than the normal range for “average” companies. However, in the chart below, I manually plugged 15 back in based on Exxon’s extremely high quality.

The purple line, which corresponds to the P/E ratio of 15 that I plugged in, is the fair-value reference line. I circled Exxon’s own P/E, which is 16.9.

Under this first method, ExxonMobil is overvalued, because its actual price (black line) is above the fair-value reference line.

Here’s how to calculate the degree of overvaluation: Make a ratio out of the two P/Es.

Formula for Measuring Valuation on FASTGraphs
Actual P/E divided by Reference P/E
16.9 / 15 = 1.13

That translates to Exxon being 13% overvalued.

Using that valuation ratio, we can calculate ExxonMobil’s fair price: Divide its actual price by the valuation ratio:

Formula for Calculating Fair Price
Actual Price divided by Valuation Ratio
$79 / 1.13 = $70

I round prices off to the nearest dollar so as not to create a false sense of precision.
Valuations are assessments, not physical traits, so we want several points of view. We’ll get those from the following steps.

Step 2: FASTGraphs Normalized Valuation

In this step, we “normalize” the fair-value reference line to reflect the stock’s own long-term valuation rather than the market as a whole.

I use the stock’s 5-year average P/E ratio (circled) for this step.

This 2nd step changes the picture. ExxonMobil is such a high quality company that the market has historically maintained a fairly high P/E multiple on the stock. Its 5-year average P/E ratio has been 17.9 (circled), which is higher than its current P/E of 16.9.

The calculations of the valuation ratio and fair price are the same as in the first step.

Valuation ratio: 16.9 / 17.9 = 0.94, or 6% undervalued
Fair price: $79 / 0.94 = $84

The stock appears to be 6% undervalued using this method. That’s pretty close to fair value; I consider anything +/- 10% to be fairly valued.

Step 3: Morningstar Star Rating

The next step is to see how Morningstar values the stock.

Morningstar takes a different approach to valuation. They ignore the P/E and other conventional valuation ratios.

Instead, they use a discounted cash flow (DCF) model. Using conservative future projections, they discount all of the stock’s estimated future cash flows back to the present to arrive at a fair value estimate. (If you would like to learn more about how DCF works, check out this excellent explanation at moneychimp.)

Here is Morningstar’s conclusion:

On Morningstar’s 5-star system, 4 stars means that they think ExxonMobil is undervalued.

Specifically, they see XOM as selling at a 12% discount, and they calculate a fair value of $90 per share.

Step 4: Current Yield vs. Historical Yield

The 4th and final valuation method is to compare the stock’s current yield to its historical yield.

If a stock is yielding more than its historical average, that suggests that it is a better value than usual, because you are “paying less” for the stock’s dividends. You can buy more shares with your money, and because dividends are paid per share, you will get more dividends for that money.

[Source: Simply Safe Dividends]

Exxon’s current yield of 4.2% is 17% higher than its average 5-year yield of 3.6%.

To calculate the degree of discount, we again form a ratio, this time comparing the yields:

Formula for Measuring Valuation by Comparing Yields
5-Year Average Yield divided by Current Yield
3.6% / 4.2% = 0.86

That would suggest 14% undervaluation. Using 0.86 as our valuation ratio, we get a fair price of $79 / 0.86 = $92.

ExxonMobil’s Valuation Summary

Now we average the 4 approaches.

The average of the 4 fair-price estimates is $84, compared to Exxon’s actual price of about $79. That’s a 6% discount to fair value. Being within +/- 10%, I think ExxonMobil is fairly valued right now.

Closing Thoughts

ExxonMobil is a very high quality business, as we saw at the beginning of the article. It also has a very attractive yield of 4.2% to go with its 36-year streak of raising its annual dividend payout. Its mid-single-digit dividend growth rate is good for a stock with a yield above 4%.

I see ExxonMobil as selling at an attractive valuation right now, with a 6% discount to a fair price of $84.
For further insight, please see these articles:

• My colleague Richard Robinson wrote favorably about Exxon in this January, 2019 article: ExxonMobil (XOM) is a Buy-and-Hold Stock.
• My colleague Brian Bollinger included ExxonMobil in DTA’s most recent report on the 10 Best Stocks to Own for Retirement, published just last week.

This is not a recommendation to buy ExxonMobil. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future, as well as its effect on your portfolio’s diversification. And be sure to consider whether it fits (or does not fit) your long-term investing goals.

— Dave Van Knapp

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