Investing is so much easier than it used to be.
It’s cheaper and faster in every possible way.
Friction, in terms of both costs and information, has been almost completely eradicated.
Commission fees have effectively been reduced to zero.
Simultaneously, there’s been a massive eruption of information accessibility.
Take the Dividend Champions, Contenders, and Challengers list, for example.
This list has compiled valuable data on hundreds of US-listed stocks
Every stock on that list has raised dividends each year for at least the last five consecutive years.
And this list is easily and freely accessible.
I’ve been referring to this list for years now, using it as a source of information as I’ve gone about using the dividend growth investing strategy to help me build wealth, passive income, and freedom.
This is an investment strategy whereby you buy and hold shares in world-class businesses that pay safe, growing dividends to their shareholders.
After all, growing dividends cannot be afforded for too long without producing growing profits.
And growing profits aren’t typically produced by terrible businesses.
So it’s very circular and intuitive.
Employing this strategy has allowed me to build the FIRE Fund.
That’s my real-money portfolio, and it generates enough five-figure passive dividend income for me to live off of.
Indeed, I’ve been fortunate enough to be in the position of being able to live off of dividend income since I retired in my early 30s.
My Early Retirement Blueprint shares how I was able to retire so early in life.
While costs have gone down and information has gone up, some elements of investing remain timeless.
Specifically, no matter what, one should aim to invest when a valuation is advantageous.
Price will always be what you pay, and value will always be what you 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.
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.
It’s never been easier or cheaper to research and invest in high-quality dividend growth stocks when they’re undervalued, which is why now is the best time in history to invest.
Extending on the theme I laid out earlier, information on the valuation process has also never been more accessible.
My colleague Dave Van Knapp’s Lesson 11: Valuation, which is a valuation guide for dividend growth investors, is a perfect example of this.
His guide provides an easy-to-follow valuation template that can be applied toward almost any dividend growth stock out there.
And this guide is free of charge.
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…
NextEra Energy Inc. (NEE) is an American energy company.
Founded in 1925, NextEra Energy is now a $135 billion (by market cap) power utility monster that employs around 15,000 people.
NextEra Energy is one of the largest electric power companies in North America.
By market cap, it’s the largest utility holding company in the US.
NextEra Energy reports results across two segments: : Florida Power & Light, 89% of FY 2022 earnings; and NextEra Energy Resources, 7%. Corporate and Other accounts for the remainder.
FPL operates the largest electric utility business in Florida, providing electricity to over 12 million people across the state of Florida.
FPL is America’s largest electric utility that sells more power than any other utility.
FPL’s energy mix for 2022 was 71% natural gas, 21% nuclear, 5% solar, and 3% other.
NextEra Energy Resources is the world’s largest generator of renewable energy from the wind and sun, and it’s also a world leader in battery storage.
What I like about NextEra Energy is that it offers something to like for both old-line utility fans and those that are clamoring for renewables.
NextEra Energy, as its corporate name implies, is preparing for the next era of energy through the heavy investment in and usage of solar and wind power generation, along with battery storage.
The world has been slowly moving toward newer forms of energy, meaning that utility companies that can adapt will be those best situated to thrive in the future.
At the same time, the company is firmly rooted in our current reality, generating reliable electricity for people who count on it through traditional sources such as natural gas.
After all, what makes the idea of investing in a power utility company appealing is that we cannot live in a modern-day society without reliable access to electricity.
It’s a non-negotiable need, which creates captive customers and highly recurring revenues.
Furthermore, there’s FPL’s favorable exposure to Florida.
Florida has been one of the fastest-growing states in the US, and it’s also a jurisdiction that has historically had a constructive regulatory framework.
The all-of-the-above approach has proven itself to be a winning strategy for NextEra Energy and its shareholders.
What we have here is a rare case of a dependable utility with growth characteristics – a best-of-both-worlds scenario.
Its traditional regulated utility operation has a favorable geographic footprint with underlying population growth, and its unregulated renewable operation is exposed to capital inflows for power generation projects that are future-oriented.
A passage from Morningstar keys in on this: “NextEra Energy’s high-quality regulated utility in Florida and fast-growing renewable energy business give investors the best of both worlds: a secure dividend and industry-leading renewable energy growth potential.”
That’s the crux of the matter.
This combination has led to, and should continue to lead to, consistent revenue, profit, and dividend growth.
Dividend Growth, Growth Rate, Payout Ratio and Yield
To date, NextEra Energy has increased its dividend for 29 consecutive years.
That impressive track record makes NextEra Energy a vaunted Dividend Aristocrat – one of only three utilities that can claim this status.
Even more impressive, perhaps, is the 10-year dividend growth rate of 11%.
This makes NextEra Energy quite unique.
In my view, it’s the result of that powerful one-two punch described above.
Along with this relatively high dividend growth rate, the stock yields 2.8%.
This is a lower yield than what many other energy utilities offer, but the much higher growth rate more than makes up for it.
That yield, by the way, is 70 basis points higher than its own five-year average.
And the dividend is protected by a 60.9% payout ratio, based on midpoint guidance for this year’s adjusted EPS.
Slightly elevated but unconcerning.
NextEra Energy has one of the best dividend growth profiles of all energy utilities, and its Dividend Aristocracy only adds to the appeal.
Revenue and Earnings Growth
As appealing as these dividend metrics may be, many of the numbers are looking backward.
However, investors must look forward, as the capital of today is getting risked for the rewards of tomorrow.
That’s why I’ll now build out a forward-looking growth trajectory for the business, which will be highly useful when it later comes time to estimate intrinsic value.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
I’ll then reveal a professional prognostication for near-term profit growth.
Amalgamating the proven past with a future forecast in this way should allow us to roughly gauge where the business could be going from here.
NextEra Energy advanced its revenue from $15.2 billion in FY 2013 to $21 billion in FY 2022.
That’s a compound annual growth rate of 3.7%.
Meanwhile, earnings per share grew from $1.12 to $2.90 (adjusted) over this period, which is a CAGR of 11.2%.
We can see how nicely the 10-year dividend growth rate lines up with EPS growth over this period, which shows excellent control from management.
These numbers can be looked at in two different ways.
In absolute terms, this growth is not outstanding.
There are many businesses out there growing faster than NextEra Energy.
In relative terms, the growth is downright remarkable.
I don’t think there’s a single energy utility out there growing its profit and dividend faster than NextEra Energy.
Looking forward, CFRA believes that NextEra Energy will compound its EPS at an annual rate of 9% over the next three years.
I don’t think this is an unreasonable expectation, although it would be on the high end of what NextEra Energy can likely produce over the next few years.
For reference, the company most recently reported 8.6% YOY growth in adjusted EPS for Q2 FY 2023.
The company itself has been guiding for 6%-8% annual adjusted EPS growth from 2024 through 2026.
I especially like this part of forward-looking guidance from the company: “NextEra Energy also continues to expect to grow its dividends per share at a roughly 10% rate per year through at least 2024, off a 2022 base.”
If we look out beyond 2024, I’m pretty confident that NextEra Energy will have to bring that dividend growth down just a bit.
If bottom-line growth comes in somewhere in the middle of what’s being projected, that would still allow for a high-single-digit dividend growth rate – easily beating what pretty much every other energy utility out there is providing.
CFRA states that “Longer term, we maintain a positive fundamental view based on a growing Florida economy and low customer rate uncertainty through 2026. We also note tailwinds for NEER’s renewables project backlog and FPL’s Real Zero 2045 (without credits or offsets) emissions target, supported by clean energy tax credits in the Inflation Reduction Act.”
To my mind, NextEra Energy is one of the best utilities in the US, and the next few years are setting up very nicely for EPS and dividend growth.
Averaging things out, I don’t see why shareholders shouldn’t expect a high-single-digit dividend growth rate over the coming years.
Starting things off with a near-3% yield pieces together a very nice picture.
Financial Position
Moving over to the balance sheet, NextEra Energy has a good financial position.
The long-term debt/equity ratio is 1.1, while the interest coverage ratio is over 7.
Although these numbers aren’t exceptional on their own, NextEra Energy has a better balance sheet than any other energy utility that I’ve ever looked at.
Profitability is also quite robust for the industry.
Net margin has averaged 21.8% over the last five years, while return on equity has averaged 11.5%.
Utilities aren’t known for high returns on capital, but NextEra Energy is relatively strong here.
In my view, NextEra Energy is the best power utility business in the US.
And with economies of scale, a geographic monopoly, a unique structure, the favorable footprint, and a constructive regulatory structure that nearly guarantees some level of profit, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
Regulation is a double-edged sword.
Regulators allow for utilities to make a reasonable profit, where profit scales with costs, putting a profit floor in place.
On the flip side, because electricity is necessary and there’s often only one power provider in any one geographic area, regulators put a ceiling on profit by limiting the rates a utility can charge.
This is a rare industry in which competition is practically nil, as NextEra Energy runs local monopolies across its territory.
That said, customers could become competition in the future through the generation of power at the site of consumption (by way of solar).
Since utilities lack the ability to meaningfully expand their coverage areas, geographic risk is present.
NextEra Energy’s FPL is captive to the regulatory structure and population growth of Florida, but Florida is currently one of the best possible states to run a regulated utility.
Indeed, Morningstar states: “The company’s below-average retail rates have garnered comparatively favorable treatment in the already-constructive Florida regulatory jurisdiction. [FPL] enjoys above-average returns on equity, forward-looking rate adjustments, and automatic general base-rate adjustments for investments upon completion.”
Nuclear risk is present.
Natural disaster risk is also present, especially since Florida is vulnerable to hurricanes.
The economics surrounding renewables are still questionable, and it remains to be seen how economically successful NEER will ultimately be.
Overall, I view these risks as pretty common and standard for a power utility, even though NextEra Energy is probably the best of its kind.
And with the stock down almost 25% from its 52-week high, this best-in-class business looks attractively valued…
Stock Price Valuation
The stock’s P/E ratio is sitting at 16.9.
There are far worse power utilities commanding higher multiples than that… right now.
The five-year average P/E ratio isn’t comparable in this case, due to adjustments.
However, we can drill down into cash flow, which is much easier to compare.
The P/CF ratio of 16.6 is below its own five-year average of 17.2.
And the yield, as noted earlier, is significantly 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 7.5%.
That’s a high expectation for a power utility like this.
If it were any other business, I’d be using a lower number.
However, NextEra Energy is unique.
It has proven a rare ability to grow at a high rate for a long time, and I’ve never seen this level of excellence from any other American power utility.
When I’m confronted with excellence, I give the benefit of the doubt and move my expectations up.
Based on the company’s near-term guidance, as well as what CFRA is projecting, it seems likely that NextEra Energy will actually outpace this growth rate over the next year or two, but it will probably then settle down into a level that’s closer to what I’m modeling in.
The DDM analysis gives me a fair value of $80.41.
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 think I was being overly aggressive, yet the stock 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 NEE as a 4-star stock, with a fair value estimate of $82.00.
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 NEE as a 3-star “HOLD”, with a 12-month target price of $82.00.
I came out slightly low, but we’re all in a very tight range. Averaging the three numbers out gives us a final valuation of $81.47, which would indicate the stock is possibly 16% 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 NEE’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 99. 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, NEE’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.
