Undervalued Dividend Growth Stock of the Week: Comcast (CMCSA)

Warren Buffett has provided us with so many timeless quotes over the years.

Peering through folksy language reveals a ton of wisdom.

Buffett’s affable nature can sometimes disguise his brilliance.

One quote, in particular, is a perfect example of this:

“Whether we’re talking about stocks or socks, I like buying quality merchandise when it is marked down.”

How could I possibly say it any better?

My favorite store in the world is the stock market.

And my favorite merchandise?

High-quality dividend growth stocks.

These stocks represent equity in some of the best businesses in the world.

Longstanding track records of paying safe, growing dividends to shareholders are illustrative of their quality.

After all, you can’t pay reliable, rising dividends without producing the reliable, rising profits necessary to fund that behavior.

And it requires you to run a great business in order to produce that reliable, rising profit.

You can see what I mean by perusing the Dividend Champions, Contenders, and Challengers list.

This list contains invaluable information on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.

You’ll find a lot of household names on that list, which shouldn’t be a surprise.

I’ve personally invested solely in these stocks over the years, building my FIRE Fund in the process.

That’s my real-money portfolio.

It produces enough five-figure passive dividend income for me to live off of.

Indeed, I do actually live off of dividends… and I’ve been doing so since I retired in my early 30s.

How did I retire so early?

My Early Retirement Blueprint spills the beans.

It should go without saying, though, that routinely putting my capital to work with high-quality dividend growth stocks has been key.

But that’s not the whole story.

Valuation at the time of investment has also been critical.

Price is simply what you pay. But it’s value that 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.

This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.

It’s protection against the possible downside.

Being able to buy great merchandise, like high-quality dividend growth stocks, while this merchandise is marked down is an opportunity to grow your wealth and passive income at even higher rates than you could have achieved before.

Of course, knowing when merchandise is marked down first requires one to understand valuation.

But this isn’t all that difficult.

Fellow contributor Dave Van Knapp has made it even easier, with Lesson 11: Valuation.

One of his “lessons” designed to teach the A-Z of DGI, it explicitly lays out a valuation process that can be easily applied toward almost any dividend growth stock out there.

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…

Comcast Corporation (CMCSA)

Comcast Corporation (CMCSA) is a media and entertainment conglomerate with interests in cable, broadcasting, film, streaming, live entertainment, and theme parks.

Founded in 1963, Comcast is now a $177 billion (by market cap) media juggernaut that employs nearly 190,000 people.

The company reports operations across five segments: Cable Communications, 53% of FY 2021 revenue; Media, 19%; Sky, 16%; Studios, 8%; and Theme Parks, 4%.

Cable Communications consists of the operations of Comcast Cable. Comcast Cable provides 17.5 million cable video connections, 30 million high-speed internet connections, and 9 million voice services.

Media consists of NBCUniversal’s television and streaming platforms. This includes a variety of cable networks, the NBC broadcast network, the Telemundo broadcast network, certain television stations, and Peacock.

Sky consists of the operations of Sky. Sky is a leading European entertainment company that provides video, broadband, voice, and wireless phone services. It is also a major content producer, via the Sky News broadcast network and Sky Sports networks.

Studios consists of NBCUniversal’s film and television studio production and distribution operations. Universal Pictures is one of the five major US film production studios.

Theme Parks consists of the worldwide Universal theme parks.

Comcast also has other business interests that consists primarily of the operations of Comcast Spectacor, which owns the Philadelphia Flyers and the Wells Fargo Center arena in Philadelphia, Pennsylvania.

Comcast is an interesting case study in perception versus reality.

The perception is that it’s a dying business.

The narrative is that people are “cord cutting” in droves, dropping cable TV bundles in favor of streaming options.

While cable TV specifically is in a state of slow decline, the reality of the situation is that Comcast as a whole is actually a growing business.

Comcast is more than offsetting the decrease in video connections through an increase in other connections.

Indeed, FY 2021 saw 1.1 million net additions to total customer relationships across Cable Communications, largely thanks to strength in broadband.

And that’s the crux of the matter here.

Reliable, high-speed access to the Internet is more important than ever, especially with people starting to work from home in larger numbers after the pandemic.

Well, Comcast is the largest provider of broadband connectivity in the United States.

Since streaming television requires high-speed internet access, Comcast retains a lot of that consumer spending.

There is simply a shift in the spending.

Also, Comcast is becoming a force of their own in streaming.

The company launched Peacock in 2020. This is their streaming platform. It already has 24.5 million monthly active accounts in the US alone at the end of FY 2021.

Less than two years in, Comcast is a major player in the disruptive technology affecting their traditional cable television business. Comcast is disrupting itself.

Furthermore, Comcast is much, much more than its cable operations.

We’re talking about a global media and entertainment behemoth here.

This is why Comcast posts up great numbers, year in and year out.

And it’s why they should continue grow their revenue, profit, and dividend for many years more.

Dividend Growth, Growth Rate, Payout Ratio and Yield

Already, Comcast has increased its dividend for 15 consecutive years.

They’re off to a great start, with a 10-year dividend growth rate of 16.3%.

Now, there has been some recent deceleration in dividend growth, but it seems like we’re settling into a high-single-digit range.

The most recent dividend increase, for example, was 8%.

I think that’s plenty of growth when you’re looking at a starting yield of 2.8% on the stock.

This market-beating yield, by the way, is 60 basis points higher than its own five-year average.

And with the payout ratio sitting at a low 34.8%, the dividend has a healthy cushion.

I like dividend growth stocks in what I call the “sweet spot” – a yield between 2.5% and 3.5%, paired with high-single-digit (or better) dividend growth.

We’re clearly in the sweet spot here.

Revenue and Earnings Growth

As true as that may be, many of these dividend metrics are looking backward.

However, investors have to risk today’s capital for tomorrow’s rewards.

To that point, I’ll now build out a forward-looking growth trajectory for the business, which will later be instrumental when it comes time to estimate intrinsic value.

I’ll first show you what this company has done over the last decade in terms of top-line and bottom-line growth.

And then I’ll unveil a professional prognostication for near-term profit growth.

Amalgamating the proven past with a future forecast in this manner should give us some idea as to where the business may be going from here.

Comcast advanced its revenue from $62.6 billion in FY 2012 to $116.4 billion in FY 2021.

That’s a compound annual growth rate of 7.1%.

Meanwhile, earnings per share grew from $1.14 to $3.04 over this period, which is a CAGR of 11.5%.

Strong top-line and bottom-line growth here.

A ~14% reduction in the outstanding share count over the last decade helped to propel much of this excess bottom-line growth.

Again, there’s nothing “dying” about this business.

Looking forward, CFRA believes that Comcast will compound its EPS at an annual rate of 12% over the next three years.

This would be right in line with what Comcast has already done over the last decade.

In essence, CFRA is assuming a continuation of the status quo.

I don’t see any convincing reasons why one wouldn’t assume a continuation of the status quo.

I see two germane issues at play here.

First, CFRA points to “favorable mix shifts to high-margin connectivity businesses as well as growth in high-speed data and business services.”

Second, CFRA is looking at “a firming recovery path for NBCU’s advertising, TV/film content, and theme parks businesses — benefiting from pent-up demand. Meanwhile, with the cable broadband business recently riding some demand tailwinds, the company has increasingly pivoted to a broadband-led connectivity strategy and gained significant traction in its nascent wireless offering.”

Losses on the video side of the business are more than being made up for higher-margin offerings on the broadband side of the business.

Simultaneously, pent-up demand for entertainment should boost the overall business.

It’s very well possible, if not likely, that Comcast is a better business coming out of the pandemic than it was going into it.

And so to assume that the business will grow at a slower rate than it was before would be silly, in my view.

Using CFRA’s near-term EPS growth forecast as our base case, Comcast could easily continue to increase its dividend at a high-single-digit rate for the foreseeable future.

Pairing that with a near-3% yield paints a nice picture in terms of the combination of yield and growth.

Financial Position

Moving over to the balance sheet, the company has an okay financial position.

The long-term debt/equity ratio is 1.0, while the interest coverage ratio is over 5.

Don’t get me wrong.

Comcast is indebted, and I’d like to see the balance sheet improve.

However, they’re not in any kind of danger whatsoever.

Profitability is robust.

Over the last five years, the firm has averaged annual net margin of 14.7% and annual return on equity of 19.9%.

It’s strange to see such a disconnect between perception and reality.

Despite the narrative around cable TV and a dying business model, Comcast just keeps putting up excellent numbers.

And the business is defended by durable competitive advantages that include large economies of scale, high barriers to entry, and the ability to operate as a local monopoly in many markets.

Of course, there are risks to consider.

Regulation, litigation, and competition are omnipresent risks in every industry.

Regulation is a rising issue in the industry, but Comcast benefits from limited (or no) competition across local markets.

While the “cord-cutting” phenomenon is overblown when looking at the totality of operations, cable video disconnections negatively and disproportionately affect the company in two ways: This hurts both the distribution (through cable video) side of the business and the production (through cable networks) side of the business. Less consumers watching traditional cable television networks is a “double whammy” for Comcast.

Comcast also faces technological obsolescence risk. If better and/or cheaper internet access, such as 5G wireless, can be scaled by a competitor, this would almost certainly reduce demand for broadband connectivity.

I see the balance sheet as a risk. The indebtedness limits their future flexibility.

Finally, theme parks have been temporarily impacted by the pandemic, but we are starting to move past this issue.

I think one should thoughtfully consider these risks, but the valuation appears to be pricing much of it in already.

With the stock down nearly 40% from its 52-week high, the stock looks severely undervalued…

Stock Price Valuation

The P/E ratio is 12.7.

To be fair, the stock never really commands a high earnings multiple, but this is still well off of its own five-year average P/E ratio of 15.8.

Also, the P/CF ratio of 6.4 isn’t even close to its own five-year average of 8.2.

And the yield, as noted earlier, is significantly higher than its own five-year 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 8%.

That dividend growth rate is as high as I’ll go, and I am somewhat surprised that Comcast seems to deserve it, but the numbers pan out.

This is a dividend growth rate I’ve repeatedly used for Comcast – for good reason.

After all, this is a company that has produced double-digit dividend growth for years, supported by double-digit EPS growth over that time.

Even during a challenging time, the company still came through earlier this year with an 8% dividend increase – right in line with my model.

With a low payout ratio and the expectation that the company will continue to grow the bottom line at a double-digit rate for the foreseeable future, I fail to see how or why Comcast would be unable to deliver high-single-digit dividend growth.

I usually do like to err on the side of caution, but I believe this is already a cautious take on the long-term growth trajectory.

The DDM analysis gives me a fair value of $58.32.

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 don’t see my valuation as overly aggressive at all, yet the stock still comes out looking very 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 CMCSA as a 5-star stock, with a fair value estimate of $60.00.

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 CMCSA as a 4-star “BUY”, with a 12-month target price of $55.00.

I came out roughly in the middle here, but we’re all in the same neighborhood. Averaging the three numbers out gives us a final valuation of $57.77, which would indicate the stock is possibly 47% undervalued.

Bottom line: Comcast Corporation (CMCSA) is running a world-class media and entertainment conglomerate. Perception around part of the business model might be putting downward pressure on the stock, but the reality of the situation is that the business just keeps putting up excellent numbers. With a market-beating yield, a double-digit long-term dividend growth rate, a low payout ratio, 15 consecutive years of dividend increases, and the potential that shares are 47% undervalued, long-term dividend growth investors ought to be looking very closely at this stock right now.

— 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 CMCSA’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 89. 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, CMCSA’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.