Making money is great.
We need money to survive, and lots of amazing things in life can be had and achieved with money.
But you know what is better than going out and making money yourself?
Having your money make more money for you.
Being in a position where your money exponentially grows all by itself frees your time and energy up so that you can live however you want.
It’s all in the name of becoming financially independent.
And one of the best investment strategies toward this end is dividend growth investing.
This is a long-term investment strategy whereby you buy and then hold shares in world-class enterprises that pay safe, growing dividends.
You can find hundreds of examples over at the Dividend Champions, Contenders, and Challengers list – a compilation of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
You’ll notice some of the world’s best businesses on this list.
This makes sense.
After all, you pretty much have to run a great business that generates ever-more profit in order to afford those ever-larger cash dividend payments to shareholders.
This doesn’t work when you run a terrible business.
I’ve been using the dividend growth investing strategy for more than a decade.
It’s the foundation of my FIRE Fund – my real-money portfolio which produces enough five-figure passive dividend income for me to live off of.
That’s right: This strategy helped me to achieve financial independence.
And it did so at a young age, as I was able to retire in my early 30s.
If you’re wondering how I did that, my Early Retirement Blueprint explains.
As powerful as this strategy can be, there’s a lot more to it than simply investing in great businesses that pay those glorious, rising dividends.
Valuation at the time of investment is also a very important consideration.
Price is only what you pay, but value is what you ultimately 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.
Building a portfolio of high-quality dividend growth stocks that make more money for you, all while they also throw off lots of passive dividend income you can live off of, sets you up for the financial freedom you need to live life on your terms.
Now, the whole preceding section on valuation is most useful when you already understand how valuation works.
If you don’t, no worries.
Lesson 11: Valuation, written by fellow contributor Dave Van Knapp, describes it all in simple-to-understand terminology and even provides a valuation template that can be applied to just about any dividend growth stock you’ll run across.
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…
Magna International Inc. (MGA)
Magna International Inc. (MGA) is a multinational mobility solutions and technology company for automakers that designs, develops, and manufactures automotive systems, assemblies, modules, and components.
Founded in 1957, Magna is now a $12 billion (by market cap) leading manufacturer that employs approximately 165,000 people.
FY 2023 revenue can be broken down by product category: Body Exteriors & Structures, 41%; Power & Vision, 33%; Seating Systems, 14%; and Complete Vehicles, 13%.
The small Corporate & Other segment reconciles the remainder.
Based out of Canada, Magna is one of the world’s largest manufacturers of OEM components for various automakers.
Magna is massive in scope and breadth.
The company is so broad, in fact, it could just about manufacture complete vehicles all by itself (if it wanted to).
Morningstar points this out: “Many suppliers focus on a particular area of the vehicle. In sharp contrast, Magna’s capabilities are so broad that the firm could nearly design, develop, supply, and assemble vehicles all on its own.”
Why do I point this out?
It’s because today’s vehicles are extremely complex.
Between EV/hybrid features, some self-driving capabilities, and suites of high-tech features, modern-day vehicles are practically computers on wheels.
As such, OEMs are looking to partner with highly capable manufacturers that have the expertise to handle this complexity across the entire chassis.
In this regard, there is no manufacturer in this space that can beat Magna.
Moreover, once an OEM is partnering with Magna, there’s a high degree of likelihood that the relationship will continue.
I mean, why would an OEM go through the costs and headaches to downgrade to a lesser manufacturer?
With switching costs and this “stickiness” in place, Magna is in the driver’s seat (pun intended).
And that’s why the company should continue to drive (again, pun intended) its revenue, profit, and dividend higher for years to come.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Already, Manga has increased its dividend for 15 consecutive years.
A very nice start on its way to becoming something even bigger.
The 10-year dividend growth rate of 11.1% is excellent, although more recent dividend raises have tracked lower as the business has struggled – a five-year dividend growth rate of 6.9% gives you an idea of the deceleration in dividend growth that’s occurred.
However, while growth has slowed, the yield has risen.
This stock now yields a market-smashing 4.7%.
It’s kind of shocking to see this stock with this yield.
It’s in the yield territory usually reserved for yield plays like utilities and REITs.
To put it in perspective, this yield is 190 basis points higher than its own five-year average.
Remarkable.
Whether or not the higher yield is worth the drop in growth depends on your age, orientation around income, and your outlook on Magna’s ability to return to prior ways.
Either way, there’s a lot of income to be had on a stock that is typically not a big income producer.
And with a payout ratio of just 55.2%, this higher-than-usual yield isn’t in any apparent danger.
With the yield being where it’s at, even only mid-single-digit dividend growth is enough to move the needle.
For dividend growth investors who are sensitive to yield, Magna’s stock is very interesting right here.
Revenue and Earnings Growth
As interesting as these metrics may be, though, some of them are looking in the rearview mirror.
However, investors must always be looking through the windshield, as today’s capital gets put on the line and risked for tomorrow’s rewards.
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 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.
Blending the proven past with a future forecast in this way should give us enough information to roughly gauge where the business might be going from here.
Magna moved its revenue from $34.4 billion in FY 2014 to $42.8 billion in FY 2023.
That’s a compound annual growth rate of 2.5%.
Hard to be wowed by this.
But Magna was held back for a number of years because of pandemic-related manufacturing shutdowns.
The company’s revenue was causing along nicely (rising pretty consistently, year after year) until FY 2020 – it dropped more than 17% on a YOY basis that year.
Magna has recovered (on revenue), with revenue for FY 2023 up 13.1% on a YOY basis and solidly higher than it was before the pandemic hit.
Meanwhile, earnings per share grew from $4.34 to $4.23 over this period.
This is effectively flat bottom-line growth.
Obviously, this isn’t what any shareholder – or prospective shareholder – wants to see.
Again, though, this disappointing results has to be viewed within the context of the pandemic and how that impacted Magna.
It’s not a situation where Magna itself had a problem or caused some self-inflicted wound.
This was a once-in-a-century extraneous event that caused unprecedented shutdowns and disruptions.
I’d argue that using the last decade – one of the worst possible 10-year periods for this business – as a proxy for long-term growth is unfair and inaccurate.
If we were to back up to the decade before the pandemic hit and go from FY 2019 back, the 10-year EPS CAGR jumps to 11.6%.
Even if you forget about the pandemic for a moment, this is a cyclical business anyhow and different points in different cycles will yield different results (for better or worse).
Under the best of circumstances, Magna can look amazing or rather ho-hum (depending on the specific points you use).
Of course, we can’t make (or lose) money on what’s already happened.
Ultimately, what matters most for investors of today is where the business is likely to go from here.
Looking forward, CFRA is forecasting a 14% compound annual growth rate for Magna’s EPS over the next three years.
That’s more like it, right?
FY 2023 showed evidence of a strong recovery for Magna (EPS more than doubled), and CFRA sees more of this ahead.
The last decade was not good at all for bottom-line growth.
The decade prior was great.
And the next few years ahead could see a return of that greatness.
It all comes down to the fact that auto manufacturing is back in full swing, as OEMs are trying to bring more inventory to market after shutdowns created shortages.
Moreover, beyond the general return to normalcy, there are additional growth drivers for Magna.
CFRA points this out: “We also view [Magna] as a winner from the secular growth of EVs and autonomous vehicle (AV) technologies over the next decade, and expect its Power & Vision segments to grow faster than other segments as a result.”
This circles back around to the point I made earlier on the growing complexity of today’s vehicles and how that plays into Magna’s breadth, scope, expertise, and ability to handle complex manufacturing processes.
If we take CFRA’s number as our base case, that easily allows for Magna to grow the dividend at, say, a mid-single-digit rate over the next few years, allowing the payout ratio to come down a bit and open things up for even bigger dividend raises down the road once that leeway is built.
Before the pandemic hit, Magna was growing EPS and the dividend at a low-double-digit rate.
It seems more than possible that something at least close to this returns.
Meantime, those buying in now are getting paid to wait with a near-5% yield.
Could do a lot worse than that, I think.
Financial Position
Moving over to the balance sheet, Magna has a good (but not excellent) financial position.
The long-term debt/equity ratio is 0.4, while the interest coverage ratio is over 5.
That latter number is low and mildly concerning, but it’s also being negatively skewed by temporary impacts to profit.
Although Magna has fully recovered on revenue, its profit still isn’t back to where it was before the pandemic hit.
All that said, the debt load isn’t super high for a company of this size.
Magna ended FY 2023 with ~$3 billion in net long-term debt (against a market cap of ~$12 billion).
I’d like to see a better balance sheet, but Magna does run a capital-intensive, cyclical business model.
Not surprising to see some debt.
Profitability is acceptable, but this, too, could be improved (although it’s important to acknowledge that this has also been harmed by recent events).
Return on equity has averaged 9.6% over the last five years, while net margin has averaged 2.8%.
I’ll note that ROE used to hover around the 20% mark before FY 2020.
It came in at about 10% for FY 2023.
A simple normalization here could be a nice tailwind for results over the coming years.
Overall, Magna is still wounded, but this has historically been one of the world’s premier manufacturers for OEMs, and it wouldn’t take much for it to fully return to former glory.
And with economies of scale, technological know-how, barriers to entry, and switching costs, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
Input costs are highly volatile.
The company has customer concentration risk: Magna’s six largest customers account for nearly 80% of its annual sales.
Demand for autos and auto manufacturing is tied to many factors beyond Magna’s control.
There is direct exposure to economic cycles, and that is amplified by the capital-intensive nature of the business model.
Global supply chains are evolving and changing, and this may impact the business in the future.
Constant technological changes in mobility means Magna must constantly stay ahead of the curve so that it doesn’t get left behind.
Some of the world’s largest automakers are having financial challenges right now, which could bleed down into Magna’s finances.
The company’s international footprint exposes it to geopolitical risks and currency exchange rates.
There are definitely some risks here, but the stock’s 60% fall from all-time highs is certainly pricing in lots of risk.
And this massive fall from grace has created a rock-bottom valuation…
Valuation
The stock is trading hands for a P/E ratio of 12.
Even for a stock that is often priced in an undemanding way, this is low.
Its well below the stock’s own five-year average P/E ratio of 14.8.
It’s also about half that of the broader market’s earnings multiple.
Furthermore, this low multiple is on earnings that haven’t fully recovered yet.
So it’s a low multiple on low earnings.
A bounce back in both could be a dual driver of returns.
The P/CF ratio of 4.2 is silly low, and it’s noticeably off of its own five-year average of 5.8.
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%.
This is on the lower end of what I typically allow for in this model.
Because of the capital-intensive, cyclical nature of this business model, pandemic scars still evident, and major automakers having troubles, I’m erring on the side of caution.
While this is well below the near-term expectation for EPS growth, Magna has had a “lost decade”.
I’d be shocked if Magna can’t muster this kind of mid-single-digit dividend growth over the coming years, and I actually think there’s room for an upside surprise.
A better environment for Magna is likely coming.
However, I also believe it’d be irresponsible to model in a high growth rate for this kind of business.
In my view, this is a realistic model for Magna.
The DDM analysis gives me a fair value of $57.81.
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.
With a model that was not aggressive at all, the stock still looks materially undervalued.
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 MGA as a 4-star stock, with a fair value estimate of $64.00.
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 MGA as a 3-star “HOLD”, with a 12-month target price of $42.00.
I’m between these two. Averaging the three numbers out gives us a final valuation of $54.60, which would indicate the stock is possibly 24% undervalued.
Bottom line: Magna International Inc. (MGA) is a top-tier manufacturing partner with unrivaled scale, scope, breadth, and expertise. Growing complexity across mobility means Magna’s capabilities have never become more important or valuable. With a market-smashing yield, a reasonable payout ratio, a double-digit long-term dividend growth rate, 15 consecutive years of dividend increases, and the potential that shares are 24% undervalued, dividend growth investors who lean toward yield and value should take a close look at this stock after its 60% fall.
-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 MGA’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 70. 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, MGA’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
Disclosure: I have no position in MGA.
