Investing can be a bit like religion.
A lot of different systems out there.
One has to find what works for them.
I’ve looked at pretty much every investing system known to man.
And there’s one that pops out to me as being superior.
It’s dividend growth investing.
This system is one whereby an investor buys and holds shares in world-class businesses that pay safe, growing dividends to shareholders.
That’s because it is.
And there’s beauty in the simplicity.
To see what I mean, take a look at the Dividend Champions, Contenders, and Challengers list.
This list has compiled invaluable information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
There are hundreds of stocks on this list, and many of them are household names.
For good reason, too, as it takes a special kind of business to be able to consistently pay and raise cash dividends to shareholders.
I’ve been using this strategy for myself for more than a decade now.
It’s helped me to build the FIRE Fund.
That’s my real-life, real-money portfolio, and it generates enough five-figure passive dividend income for me to live off of.
How exactly I was able to retire so early in life is spelled out in my Early Retirement Blueprint.
A lot of my success hearkens back to the system, but it’s more than just selecting the right businesses to invest in.
This system also involves valuation.
Whereas price represents what you pay, value represents 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.
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.
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.
There are a lot of investment systems and a lot of ways to make money, but routinely buying undervalued high-quality dividend growth stocks has to be one of the simplest and most effective ways of all.
Now, this idea, while simple on its face, does require one to have a basic understanding of valuation.
Well, this is where fellow contributor Dave Van Knapp’s Lesson 11: Valuation comes in.
Part and parcel of a comprehensive series of “lessons” designed to teach dividend growth investing, it lays out a valuation template that can be used to estimate the fair value of just about 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…
American Tower Corp. (AMT) is a real estate investment trust that owns, operates, and develops broadcast communications infrastructure across the world.
Founded in 1995, American Tower is now an $80 billion (by market cap) real estate infrastructure monster that employs more than 6,000 people.
The company’s main tower portfolio includes approximately 225,000 communications sites, with more than 40,000 in the US and roughly 180,000 internationally.
American Tower also operates a portfolio of 28 data centers across eight different markets in the US.
What American Tower does is fairly straightforward: The company erects and then rents out vertical antenna sites to service providers.
Service providers sign multiyear leases in order to access towers and install their equipment.
This equipment is necessary to carry out services such as telephony, mobile data, radio, and broadcast television.
In addition, after the acquisition of CoreSite Realty Corporation in late 2021, American Tower owns and operates interconnected data center facilities.
American Tower expects this acquisition to enhance the value of its existing tower real estate through emerging edge computing opportunities.
Regardless of precisely how that works out, 5G and IoT are converging to make American Tower’s infrastructure more necessary and important than ever before.
This is due to rapidly rising consumption of high-speed, low-latency data.
It started with personal computers and smartphones, but it’s since moved into almost all aspects of society.
For instance, vehicles, which now have embedded advanced infotainment systems, are slowly gaining the ability to drive themselves, and this seemingly small advancement will require exponentially more high-speed, low-latency data.
The way in which our various everyday devices – think innocent items such as household appliances – are becoming more interconnected (i.e., IoT) translates into escalating demand for access to data.
And there may be a near-term future in which AI-powered robots require 24/7 access to data in order to remain powered and effective.
So on and so forth, which means there’s a demand floor in place here.
Moreover, American Tower has a unique advantage built right into the business model.
It’s the way in which its real estate can be easily leveraged, and this is unlike any other kind of real estate.
Once a tower is built, there is massive amounts of immediate scalability.
Each tower is a bit of a compounding money machine for American Tower: Adding tenants, equipment, and upgrades results in much higher returns per tower, as revenue is added with minimal incremental cost.
I’d go so far as to call this American Tower’s “secret sauce”.
Imagine having thousands of these compounding money machines built out across the world.
Well, that’s how American Tower has become a bit of a compounding money machine, which shows up in its revenue, profit, and dividend growth.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, American Tower has increased its dividend for 14 consecutive years.
The 10-year dividend growth rate of 19.1% is outstanding, especially for a REIT (REITs tend to be low-growth income vehicles), but it’s important to note that more recent dividend raises have been quite a bit smaller.
In fact, American Tower actually temporarily reduced the size of its most recent dividend declaration, but that was only because management had lived up to prior commitments in 2023 and had to right-size the dividend.
Growth has slowed as American Tower has grown and matured, and recent trends in telecom (e.g., consolidation) have added challenges.
On the flip side, the market has adjusted the stock’s yield higher (by sending the stock’s pricing down on a lower valuation) in order to compensate for this.
To this point, the stock’s 3.7% yield is 160 basis points higher than its five-year average.
American Tower has historically had a very low yield for a REIT (because it was growing so quickly).
However, American Tower is now starting to look a lot more like a typical REIT (i.e, a low-growth income vehicle).
If one is an income-oriented investor, it may be more appealing than it ever has been before.
With a payout ratio of 62.2%, based on midpoint guidance for FY 2024 adjusted FFO/share, the dividend is healthy and easily covered.
If American Tower can get back to a higher growth rate after some near-term headwinds abate, that gives investors a chance to “lock in” a higher-than-average yield right before growth reaccelerates.
It’s a REIT-like yield with an option for growth that could be far better than most REITs.
Not bad at all.
Revenue and Earnings Growth
As interesting as this setup may be, though, some of these dividend metrics are looking backward.
But investors must always be looking forward, as today’s capital gets risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will come in handy when the time comes later to estimate fair 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.
And I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast like this should give us the information we need in order to approximate where the business may be going from here.
American Tower increased its revenue from $4.1 billion in FY 2014 to $11.1 billion in FY 2023.
That’s a compound annual growth rate of 11.7%.
This is very solid.
I’m usually looking for a mid-single-digit top-line growth rate from a mature business.
American Tower has done far better than that.
However, when it comes to REITs, it’s imperative to look at profit growth on a per-share basis.
See, REITs use debt and equity to fund growth, as they’re legally required to distribute at least 90% of their taxable earnings to shareholders.
This circles back around to the point I made earlier on REITs primarily being income plays, and the limitations around internal funding for growth often results in tapping equity (by issuing shares and diluting existing shareholders).
That tends to create distortion between absolute revenue growth and profit growth relative to shares outstanding.
Also, when assessing profit for a REIT, we want to use funds from operations instead of normal earnings.
FFO (or adjusted FFO) is a measure of cash generated by a REIT, which adds depreciation and amortization expenses back to earnings.
American Tower grew its AFFO/share from $4.54 to $9.87 over this 10-year period, which is a CAGR of 9%.
This latter number is a more accurate representation of American Tower’s true growth profile, and it’s actually still quite impressive.
Few REITs are able to sustainably grow at almost 10% per year over an extended period of time.
That said, again, American Tower has faced growth challenges of late.
The company has, in some ways, been a victim of its own success, saturating the global market with highly successful towers.
This turned American Tower into not only the largest tower REIT but one of the largest REITs in the world (by market cap).
It’s gotten tougher to move the needle on a relative basis.
Moreover, consolidation in telecom has caused downward pressure on tenants per tower and rents.
In response, American Tower has been recently focused on cost control and debt reduction.
Looking forward, CFRA doesn’t currently have a three-year projection for American Tower’s AFFO/share growth.
That is unfortunate, as it’s nice to compare the proven past against a future forecast.
But I think this passage by CFRA does a great job of summing up the long-term investment thesis here: “We are optimistic about long-term demand driven by mobile video growth, unlimited data plans, and buildouts in mid-spectrum 5G bands. International markets pose the greatest growth opportunity for [American Tower] moving forward, by our analysis. 4G penetration remains moderate in many international markets such as Latin America (currently about 50%) and Africa (around 15%). [American Tower] will continue investing significantly in these regions through both tower acquisitions and new builds, in our view.”
It’s hard to imagine any future (say, 10 years from now) in which the demand for mobile data isn’t meaningfully higher than it is today, and that plays right into the hands of American Tower.
Now, American Tower did agree to sell its India portfolio (comprising over 75,000 sites) to a Brookfield Asset Management Ltd. (BAM) affiliate for $2.5 billion.
Due to certain local economics, the Indian assets have not performed well, and this allows American Tower to better control costs and manage debt.
While this is somewhat disappointing, seeing as how American Tower’s international footprint should give it a leg up on domestic competition (because of lower 4G and 5G penetration in overseas markets), it’s important to keep in mind that American Tower is still heavily reliant on the US market.
The company gets nearly half of its revenue from the three major US telecom giants – AT&T Inc. (T), Verizon Communications Inc. (VZ), and T-Mobile US, Inc. (TMUS) – and a majority of the leases are due after 2028 (American Tower’s leases tend to run five to ten years).
When those leases are renewed, the built-in escalators (~3% in the US) will kick at a time in which American Tower has become a leaner and more focused operation.
Also, American Tower’s acquisition of CoreSite Realty Corporation was prescient, preparing the business for growing cloud demand and edge computing.
Let’s get down to brass tacks.
Management is guiding for $10.42/share (at the midpoint) for FY 2024 AFFO/share.
That midpoint number would represent 5.6% YOY growth off of FY 2023’s result.
And this is during a pretty tough stretch for the business.
In my view, somewhere between that number and what American Tower has done over the last decade is an appropriate expectation for bottom-line growth on a go-forward basis.
Let’s call it high-single-digit AFFO/share growth, which should translate to like dividend growth.
And one gets a near-4% yield to start off with.
It’s certainly not a bonanza.
But one can see a pretty uncomplicated path to 10% annualized total returns on those numbers.
Hard to get too upset with any of that.
Financial Position
Moving over to the balance sheet, American Tower has a good financial position (for a REIT).
Keep in mind, REITs use leverage by design (by tapping debt for growth), so the balance sheet must be looked at through that lens.
A common measure for a REIT’s financial position is the debt/EBITDA ratio.
American Tower finished its most recent quarter with a net debt/annualized adjusted EBITDA ratio of 5.
This is pretty average.
I typically see REITs range from 3 to 7 on this ratio, which would put American Tower right in the middle.
I’d certainly prefer to see something lower – say, around 3 – but American Tower’s leverage isn’t out of ordinary.
American Tower’s credit ratings are in investment-grade territory (albeit at the low end): BBB-, S&P; BBB+, Fitch; Baa3, Moody’s.
In my view, this is a fairly standard financial position for a REIT, but it’s far from a great balance sheet.
As an aside, large amounts of debt across the entire REIT complex is one reason why I’m not a huge fan of REITs, in general, and not heavily exposed to the REIT space in my own portfolio (I lean much more toward businesses with little/no leverage).
In the end, American Tower isn’t putting up the blistering growth it used to, but it’s still one of the better REITs out there.
And with economies of scale, switching costs, and entrenched infrastructure, 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.
A REIT’s capital structure relies on external funding for growth, which exposes the company to volatile capital markets (through equity issuances) and interest rates (through debt issuances).
Adding to the rate conversation, higher rates can hurt this particular business model twice over: Debt becomes more expensive to take on and service, and equity can become more expensive (because income-sensitive investors have alternatives, which puts downward pressure on the stock price).
American Tower’s international footprint offers more growth opportunities, but it also exposes the company to currency exchange fluctuations, idiosyncratic market dynamics, and geopolitics.
Customer concentration is a risk, as three major telecommunications companies account for almost half of the company’s revenue.
American Tower’s massive scale is an advantage, but it also introduces questions around future growth and the law of large numbers.
LEO satellites present a technological risk, as the possible viability of LEO satellites as an antenna alternative in the future could make towers obsolete.
Many of these risks are common for a REIT, but I think American Tower is a better-than-average REIT.
In addition, after the stock’s 40%+ slide from its all-time high, the stock has a below-average valuation…
Valuation
The stock is trading hands for a forward P/AFFO ratio of 17.
That’s based on midpoint guidance for FY 2024 AFFO/share.
This is somewhat comparable to a P/E ratio on a normal stock, and it just goes to show how undemanding the valuation has become after the stock’s humongous 40%+ drop from late 2021 highs.
The P/CF ratio is now at 15, which is well below its own five-year average of 21.8.
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 6.5%.
That growth rate is on the low end of my usual range, but it’s actually on the higher end of what I allow for when valuing a REIT.
I’m giving American Tower some benefit of the doubt here, as it’s demonstrated an ability to consistently grow its AFFO/share and dividend faster than a lot of other REITs.
American Tower has grown its dividend far faster than this mark over the last decade.
And the high-single-digit AFFO/share growth over the last decade is encouraging.
Even if we look at very recent growth, which is probably American Tower in its worst light, we’re still talking about mid-single-digit growth.
Again, circling back around to what I noted earlier, I think there’s a clear case for high-single-digit AFFO/share and dividend growth over the coming years.
And so I’m assuming something on the lower end of a high-single-digit growth rate.
The DDM analysis gives me a fair value of $197.18.
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 my model was overly aggressive, yet the stock still comes out looking quite 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 AMT as a 4-star stock, with a fair value estimate of $215.00.
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, unfortunately, appears to have inexplicably pulled their coverage of AMT just as I was finishing this writeup, so I don’t have a number here.
I came out a bit lower than where Morningstar is at, but both numbers are meaningfully higher than the stock’s current price. Averaging the two numbers out gives us a final valuation of $206.09, which would indicate the stock is possibly 14% 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 AMT’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 78. 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, AMT’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
Disclosure: I’m long AMT.
