There are approximately 60,000 publicly-traded companies in the world to choose from as an investor.
Narrowing it down to just the US, there are more than 4,000.
That’s a lot of choices.
So how do we narrow things down and create useful, wieldy lists?
Well, I think starting with quality is a great approach.
This is exactly what the Dividend Champions, Contenders, and Challengers list has done, using a filter to shrink an investable universe down to hundreds of stocks.
This list has narrowed things down in a big way by compiling invaluable information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
So what’s the filter?
Well, the list is basically limiting itself to US-listed stocks that qualify for the dividend growth investing strategy – a strategy that involves buying and holding shares in terrific businesses that pay reliable, rising dividends to shareholders.
Again, it’s all about quality here.
That’s because it takes a certain level of business quality in order to generate the ever-higher profit necessary to pay shareholders ever-larger cash dividends.
It’s awfully difficult to run a terrible business while simultaneously just raking in ever-more money.
Moreover, safe, growing dividends flowing into a brokerage account is awesome.
Dividends are, arguably, the most passive form of income in the world, and collecting lots of this passive income makes life a lot easier.
This helps to explain why I’ve been personally using this strategy with my own money over the last 10+ years.
It’s guided me as I’ve gone about building the FIRE Fund.
That’s my real-money portfolio, and it produces enough five-figure passive dividend income for me to live off of.
Indeed, I’ve been in the very fortunate position of being able to live off of dividend income since I quit my job and retired in my early 30s.
If you’re interested in putting yourself in a similar position, be sure to give my Early Retirement Blueprint a read.
Now, as critical as quality is, valuation is also extremely important.
Whereas price is what you pay, it’s value that 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.
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.
Focusing on undervalued high-quality dividend growth stocks automatically eliminates thousands of other investment options out there, putting some of the very best opportunities immediately on your radar and making things a lot more straightforward.
All of the preceding is, of course, assuming that one already understands the basic ins and outs of how valuation works.
If you don’t, Lesson 11: Valuation will come in handy.
Written by fellow contributor Dave Van Knapp, it provides a simple-to-understand primer on valuation and even includes a template that one can use to estimate the fair value of 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…
Jack Henry & Associates, Inc. (JKHY)
Jack Henry & Associates, Inc. (JKHY) is a financial technology company that provides a range of services to various financial financial firms.
Founded in 1976, Jack Henry is now a $13 billion (by market cap) fintech competitor that employs more than 7,000 people.
The company operates across three business segments: Payments, 37% of FY 2023 revenue; Core, 32%; and Complementary, 28%.
Essentially, Jack Henry provides fintech services for US banks and credit unions (with a focus on small and midsized institutions).
These services include electronic funds transfer, payment processing, and loan processing.
Jack Henry works with ~1,000 banks and ~700 credit unions.
What’s great about this business model is how integral it becomes to its customers.
Jack Henry facilitates a number of services for its clients, making doing business easier for these banks and credit unions by handling all kinds of critical, nuts-and-bolts processes for them through proprietary technology.
Once a relationship is established and the technology is installed, this becomes a very “sticky” setup that is easier to maintain than remove.
After all, the services are both necessary for function and relatively low in cost as a percentage of an institution’s total overhead.
This explains why client retention is almost 100%.
Moreover, and really cementing the deal, Jack Henry has its customers sign multiyear contracts.
This combination of factors creates a high degree of recurring revenue (north of 90%), giving Jack Henry incredible control over its results and long-term business visibility.
And while Jack Henry is great at locking down existing customers, it continues to expand its client base through acquisitions, new offerings, and taking market share.
All of this is allowing Jack Henry to post extremely consistent revenue, profit, and dividend growth.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, the company has increased its dividend for 34 consecutive years.
That’s an incredible dividend growth track record that flies under the radar.
It takes a special kind of business to be able to consistently not only pay but grow a dividend for more than three straight decades.
Its 10-year dividend growth rate is 11%, which is strong, although some of the recent dividend increases have been in a mid-single-digit range.
This is somewhat understandable, as its core market (i.e., US banking) has had a tumultuous time over the last few years, with bank runs, bank failures, and interest rate volatility challenging the industry.
I give Jack Henry the benefit of the doubt and assume that it can get back to at least high-single-digit dividend growth, if not low-double-digit dividend growth, over the coming years, especially seeing as how the industry has calmed down and accommodated rates.
As exciting as that normalized growth regime may be, the stock does only yield 1.3%.
That lowish yield is the compromise one must accept in order to get access to the clear commitment to the dividend and the elevated growth of it.
While this yield is certainly not juicy, it’s worth noting that it is 20 basis points higher than its own five-year average.
Said another way, the yield is actually higher than it usually is, as the market is typically willing to accept a very low yield from this stock because of the quality and growth of the business.
The payout ratio is 40.2%, giving Jack Henry plenty of room for more dividend raises.
A higher yield would be nice, sure, but this company clearly has a great dividend growth pedigree.
It’s a high-quality compounder, not an income play, making it ideal for younger dividend growth investors, or investors who don’t necessarily need the current income.
Revenue and Earnings Growth
As great as the pedigree is here, though, many of the dividend metrics I just revealed are based on what’s happened in the past.
However, investors must always be looking out toward the future, as the capital of today is being risked for the rewards of tomorrow.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will be instrumental when it comes time 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.
Blending the proven past with a future forecast in this manner should give us the kind of input we need to gauge where the business may be going from here.
Jack Henry advanced its revenue from $1.2 billion in FY 2014 to $2.2 billion in FY 2023.
That’s a compound annual growth rate of 7%.
Very solid.
I usually like to see high-single-digit (or better) top-line growth from a mature business, and Jack Henry more than delivered.
Meantime, earnings per share increased from $2.19 to $5.23 over this period, which is a CAGR of 10.2%.
Excellent.
We can now see that Jack Henry has been funding double-digit dividend growth with double-digit EPS growth, not with debt and/or messing with the payout ratio.
I’d also like to point out that growth has been secular, with very little bumpiness.
EPS is almost relentlessly up and to the right, which speaks on the value of the firm’s long-term contracts and high degree of recurring revenue.
Excess bottom-line growth has been helped along by share buybacks, with the outstanding share count down by 14% over the last decade.
Looking forward, CFRA is forecasting an 8% CAGR for Jack Henry’s EPS over the next three years.
CFRA notes: “In our view, demand from banks/credit unions has remained robust for [Jack Henry]’s competitive and cost-efficient tech solutions, which aid digital transformation, an imperative for clients in the tough economic climate.”
CFRA then adds: “We believe [Jack Henry]’s recurring-revenue-focused model offers stability for investors.”
I really couldn’t agree more with either of these statements.
In an effort to bolster its competitive moat, client “stickiness”, and growth prospects, Jack Henry recently started rolling out a cloud platform.
This platform has shown progress, which CFRA touches on: “[Jack Henry] booked six core wins, while adding four new debit and three new credit processing clients in [Q1]. [Jack Henry] made strong progress with cloud adoption, with 73% of its clients on the private cloud.”
If it’s not obvious by now, Jack Henry is running an impressive operation.
Adding its private cloud to the mix only serves to strengthen the ecosystem that Jack Henry has built up in order to serve its clients – an ecosystem with ~100% client retention.
Once in that ecosystem, it’s not straightforward, or even necessarily helpful, to leave.
Jack Henry also pursues strategic acquisitions in order to drive growth, with its 2022 acquisition of Payrailz being a great example.
Payrailz provides cloud-native, API-first, AI-enabled digital payment solutions, enabling the movement of money.
This acquisition enhances Jack Henry’s payments-as-a-service (PaaS) strategy, giving the business additional breadth and scale where it matters most.
Moreover, organic growth has outpaced peers, indicating that Jack Henry is taking share.
When you combine new offerings (R&D spending is ~15% of revenue), strategic acquisitions, and share gains, you’ve got a bit of an unstoppable juggernaut.
Circling back around to the forecast, is an expectation of deceleration in EPS growth, relative to the last decade, a reasonable one?
Well, Jack Henry itself is guiding for $5.83 in EPS for FY 2025, at the midpoint.
This would represent 11.5% YOY growth.
So that’s not a deceleration at all.
It’s an acceleration.
For me, as I stated earlier, I give Jack Henry the benefit of the doubt.
It’s earned it.
And with a business that is so unrelenting with low-double-digit bottom-line growth, even through a rather tough period, I’d be inclined to lean toward believing that the next decade will look pretty similar to the last – especially with the upcoming year showing no evidence to the contrary.
This would open up the dividend for similar (low-double-digit) dividend growth, which would closely match the demonstrated 10-year dividend growth rate.
Again, a higher yield would be nice, but I see a high-quality compounder poised to continue its compounding ways.
Financial Position
Moving over to the balance sheet, Jack Henry has a fantastic financial position.
Long-term debt is immaterial.
The long-term debt/equity ratio is less than 0.1, while the interest coverage ratio is over 35.
Jack Henry is nearly free of debt and could easily pay off all long-term debt quickly, if it wanted to.
Profitability is outstanding.
Return on equity has averaged 22.5% over the last five years, while net margin has averaged 17.7%.
The company is routinely producing high returns on capital (ROIC is in the 20% area) without employing much leverage.
This is a high-quality fintech company with a high degree of recurring revenue and client retention, backed by an effective and “sticky” ecosystem that locks in clients.
And with economies of scale, switching costs, barriers to entry, R&D, and IP, 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.
The company operates in a fairly mature US banking market that continues to consolidate, limiting its TAM and client base expansion potential.
Strategic acquisitions come with execution and integration risk.
Any kind of large-scale economic slowdown, especially a recession, could hurt Jack Henry, as banks are liable to feel the brunt of such a slowdown and may reduce IT spending as a result.
Dramatic changes in the banking sector, although not currently likely, could impact Jack Henry.
The company’s tech tilt means it must continue to innovate and stay ahead of the tech curve in order to stay relevant and keep its clients.
I don’t see a particularly high risk profile here.
I think the combination of quality and minimal risk is why the stock is almost always expensive, although it’s currently at a rare moment of relative cheapness…
Valuation
The stock is trading hands for a P/E ratio of 31.8.
In absolute terms, that’s on the higher side.
However, relative to itself, it’s actually not high at all.
To the contrary, it’s quite a bit lower than the stock’s own five-year average of 37.3.
I think the disconnect can be traced to an unusual period of underperformance.
This stock consistently outperforms the broader market, but the stock is trailing the S&P 500 by about 20% in 2024.
To this point, the cash flow multiple of 19.8 is well below its own five-year average of 23.1.
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 two-stage dividend discount model analysis.
I factored in a 10% discount rate, an 11% dividend growth rate for the next 15 years, and a long-term dividend growth rate of 8%.
Nothing unreasonable here, in my view.
I’m basically extrapolating out the last decade into the foreseeable future, assuming that Jack Henry will continue to grow the business and dividend at a low-double-digit rate.
Seeing as how the coming year is shaping up for 11.5% YOY growth, which opens up the dividend for something similar, it looks like business as usual to me.
This 11% number shows up multiple times, and that’s the number I’m comfortable with.
I’d be surprised if Jack Henry grows the dividend significantly faster or slower than this mark over the coming decade or so.
From there, it’s sensible to assume a slowdown of growth into a high-single-digit range.
The DDM analysis gives me a fair value of $171.58.
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.
The stock looks pretty fairly priced to me.
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 JKHY as a 3-star stock, with a fair value estimate of $189.00.
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 JKHY as a 3-star “HOLD”, with a 12-month target price of $185.00.
I came in low this time around. Averaging the three numbers out gives us a final valuation of $181.86, which would indicate the stock is possibly 4% undervalued.
Bottom line: Jack Henry & Associates, Inc. (JKHY) is a high-quality fintech business that has built out an effective ecosystem which locks in a very “sticky” client base by providing nuts-and-bolts processing services. On top of that, it signs customers to long-term contracts, leading to 90%+ recurring revenue on near-100% client retention. With a market-like yield, more than 30 consecutive years of dividend increases, low-double-digit dividend growth, a low payout ratio, and the potential that shares are 4% undervalued, this could be a unique opportunity to invest in a terrific business at a better-than-fair price.
-Jason Fieber
Note from D&I: How safe is JKHY’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, JKHY’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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.
Disclosure: I have no position in JKHY.
