As difficult as it might be to believe, we could be at the beginning of another decade-long bull market.
When I started investing, in early 2010, almost nobody back then could believe that a bull market had already started.
Yet that long, slow burn lasted for more than 10 years.
This one, though, coming off the pandemic-fueled crash last spring, is turning into a more explosive affair.
And that’s making it difficult to find great deals on great stocks.
However, this extra challenge might just mean extra reward.
I’d know a lot about challenges and rewards.
And that’s after starting out deeply in debt in my late 20s.
I spell out how I accomplished that in my Early Retirement Blueprint.
A major aspect of the Blueprint is the investing strategy I used.
Dividend growth investing.
This strategy espouses buying and holding shares in world-class enterprises paying reliable, rising dividends.
The Dividend Champions, Contenders, and Challengers list contains invaluable information on hundreds of these stocks.
I built out the FIRE Fund using the tenets of this strategy.
That’s my real-money dividend growth stock portfolio, and it produces enough five-figure dividend income for me to live off of.
This strategy is amazing.
Price is only what you pay, but value is what you actually 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.
It’s protection against the possible downside.
Finding a great deal on a great stock can amplify what’s already an incredibly powerful strategy.
Fortunately, those great deals aren’t all that difficult to find.
Fellow contributor Dave Van Knapp’s Lesson 11: Valuation has made the process of separating cheap from expensive a lot more simple.
Part of an overarching series of “lessons” on dividend growth investing, it provides a valuation template that can be applied to almost any dividend growth stock.
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…
Bristol-Myers Squibb Co. (BMY) is a global biopharmaceutical company that is engaged in discovering, developing, and delivering a range of medicines to help people overcome serious diseases.
Founded in 1887, Bristol-Myers Squibb is now a $146 billion (by market cap) healthcare behemoth that employs 30,000 people.
The company focuses on oncology, cardiovascular, and immunology treatments.
Three primary drugs together accounted for almost 70% of sales: Revlimid, Opdivo and Eliquis. Eliquis is jointly developed and commercialized with Pfizer Inc. (PFE).
A global biopharmaceutical company like Bristol-Myers Squibb presents the investor with a compelling investment case.
The world is growing bigger, older, and richer – simultaneously.
A larger pool of older and wealthier people naturally means more demand for, as well as access to, quality healthcare products and services (including medicine).
And since healthcare is usually a non-discretionary expense, demand for quality drugs tends to be fairly inelastic.
Already positioned favorably by these demographic tailwinds, the company further bolstered its competitive position by acquiring rival Celgene Corporation for $74 billion in late 2019.
This greatly expanded and diversified its drug portfolio, adding key blockbuster cancer drug Revlimid to the sales mix.
Revlimid produced more than $12 billion in sales in 2020, which makes it one of the top-selling drugs in the whole world. It’s the crown jewel for the combined business.
Bristol-Myers Squibb now has even greater scale, which is a powerful competitive advantage in their space.
This bodes well for the company’s ability to increase its profit and dividend over the long run.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Already, Bristol-Myers Squibb has increased its dividend for 12 consecutive years.
Their 10-year dividend growth rate of 3.5% is somewhat disappointing. This has historically dimmed my enthusiasm regarding the business.
However, there’s been a recent dividend growth acceleration.
The last dividend increase was almost 9%.
This market-beating yield, by the way, is 20 basis points higher than the stock’s own five-year average yield.
With the payout ratio at 26.3% (based on midpoint FY 2021 non-GAAP EPS guidance), the dividend should continue to grow at this accelerated rate for the foreseeable future.
I like dividend growth stocks in what I refer to as the “sweet spot” – a yield of between 2.5% and 3.5%, paired with a high-single-digit (or better) dividend growth rate.
With bigger dividend raises coming out of the business, the stock is now squarely in that sweet spot.
Revenue and Earnings Growth
As solid as these dividend metrics are, we’re looking at the past.
But it’s ultimately those future dividends and dividend raises that today’s investors care about.
Investors risk today’s capital for tomorrow’s rewards.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will later help us to estimate the stock’s intrinsic value.
I’ll first show you what the company has done over the last decade in terms of its top-line and bottom-line growth.
I’ll then compare that to a near-term professional prognostication for profit growth.
Amalgamating the proven past with a future forecast in this way should allow us to come to a reasonable conclusion about where the business might be going.
Bristol-Myers Squibb grew its revenue from $21.244 billion in FY 2011 to $42.518 billion in FY 2020.
That’s a compound annual growth rate of 8.01%.
Very impressive. However, much of this growth is due to the aforementioned Celgene acquisition.
That acquisition resulted in a much larger float for the business, with the outstanding share count exploding.
The profit growth on a per-share basis should give us better insight into the true growth profile.
Earnings per share increased from $2.16 to $6.44 (adjusted) over this period, which is a CAGR of 12.91%.
Even more impressive than the top-line growth.
It’s important to note, though, that I did use adjusted EPS for FY 2020, as the integration of the Celgene acquisition and one-time charges greatly skewed the GAAP EPS result for FY 2020.
Looking forward, CFRA is projecting that Bristol-Myers Squibb will compound its EPS at an annual rate of 10% over the next three years.
CFRA cites a healthy pipeline and the strength of its marketed brands as key long-term tailwinds.
Regarding the pipeline, there are more than 50 compounds in development.
This healthy pipeline is necessary. Patents on Revlimid begin expiring in 2022, with unrestricted competition slated to begin in 2026.
Seeing as how Revlimid is the company’s biggest sales driver and most important drug, the patent cliff looms large. The development of successful drugs is critical to their long-term success.
I see CFRA’s near-term EPS growth forecast as reasonable.
To put it in perspective, Bristol-Myers Squibb’s own non-GAAP EPS guidance for FY 2021 would imply 15.7% YOY growth at the midpoint.
This kind of bottom-line growth rationalizes the dividend growth acceleration I noted earlier.
Financial Position
Moving over to the balance sheet, the financial position is good.
While the company did take on a lot of debt to help fund the Celgene acquisition, they went into the acquisition with a fantastic balance sheet. The balance sheet simply deteriorated from an excellent level to a level that’s good.
The long-term debt/equity ratio is 1.28.
There’s currently no interest coverage ratio due to the skewing of income before taxes for the last fiscal year. Their interest coverage ratio in FY 2018 – the last full year before the Celgene acquisition – was over 30.
So I suspect that once the increased earnings base normalizes against the higher interest expenses, the interest coverage ratio will be quite acceptable.
Profitability is robust as it sits, but I suspect this will also look a lot better once things normalize.
Over the last five years, the firm has averaged annual net margin of 10.72% and annual return on equity of 16.07%.
Both numbers would be a lot higher if not for the skewing of GAAP numbers for FY 2020.
Overall, I think Bristol-Myers Squibb is more investable than it’s ever been.
The healthy pipeline, blockbuster drug lineup, and recent acceleration of growth all offer a lot to like.
And the company is protected by durable competitive advantages that include global economies of scale, R&D, IP, established sales relationships, and patents.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
Revlimid’s upcoming patent cliff is a material risk.
There remains integration risk. Celgene has to offset the weaker balance sheet with a lot of cash flow and growth.
The increased debt load also increases the company’s exposure to interest rates, and it limits future M&A opportunities.
Any major changes to healthcare in the US, especially as it relates to drug pricing, would impact the business.
And while the drug portfolio has strengthened and improved in breadth, the company remains concentrated around only a small handful of highly successful drugs. The pipeline has pressure on it to produce more blockbusters.
With these risks known, I still think this looks like a great long-term investment.
That view is reinforced by the stock’s appealing valuation…
Stock Price Valuation
The stock trades hands for a forward P/E ratio of 8.74, based on the midpoint of this fiscal year’s non-GAAP EPS guidance.
That is almost obscene in this market.
The stock’s P/S ratio of 3.4 is well off of its own five-year average of 4.2.
There’s also the P/CF ratio – at 10.6, it’s less than half that of the stock’s own five-year average P/CF ratio of 23.4.
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 7%.
This DGR is actually slightly lower than what I’ve typically used for other biopharmaceutical stocks.
Comparing this to the company’s long-term EPS growth rate, the recent dividend raise, and CFRA’s near-term EPS growth projection, it’s downright conservative.
But I see this cautious stance as appropriate.
The big acquisition is still new. The balance sheet is suddenly levered up. And there’s a patent cliff looming.
It’s certainly possible, if not likely, that the company will exceed this DGR, but I’d rather err on the side of caution.
The DDM analysis gives me a fair value of $69.91.
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.
Even after what I feel was a careful valuation, the stock still looks cheap.
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 BMY as a 3-star stock, with a fair value estimate of $68.00.
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 BMY as a 4-star “BUY”, with a 12-month target price of $72.00.
I came out right in the middle this time around. Averaging the three numbers out gives us a final valuation of $69.97, which would indicate the stock is possibly 8% undervalued.
-Jason Fieber
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.
Note from D&I: How safe is BMY’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 79. 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, BMY’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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