One of the greatest investors of all time, Peter Lynch, recommended that investors, especially new investors, look to the goods and/or services they use every day for ideas.
Great investment ideas are all around us when we take this approach.
If you’re repeatedly using and enjoying these products and/or services, odds are good that many other people are doing the same.
When you have a lot of people repeatedly buying products and/or services from a company, you can quickly develop a hunch that the company is doing quite well for itself.
And if it’s doing well, that means you can invest and also do well.
It’s a simplistic approach, but simple can be highly effective.
Just to show you how effective it can be, take a look at the Dividend Champions, Contenders, and Challengers list.
This list contains data on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
All of these stocks qualify for the dividend growth investing strategy, which is a strategy that prioritizes buying and holding shares in high-quality businesses that pay safe, growing dividends to shareholders.
I bring this up because many household names – the companies selling that which you regularly buy and use – are on that list.
And these companies are doing so well that they’re able to reward their shareholders with rising cash payments – rising cash payments which are funded by rising profits (and rising profits which are generated by selling all of those products and/or services).
Those growing dividends are a fantastic source of totally passive income that you can use however you wish.
And these growing dividends are “proof in the profit pudding”.
Can’t fake cash.
I’ve used the dividend growth investing strategy to great effect for myself, letting it guide 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.
I’m in the very fortunate position of being able to fund my entire life purely through passive dividend income.
I’ve actually been in this position since I quit my job and retired in my early 30s.
My Early Retirement Blueprint details how that was made possible.
Now, using Lynch’s advice and combining that with the dividend growth investing strategy is a very powerful way to approach long-term investing.
However, one must always consider valuation before they invest in any business.
That’s because price only tells you what you pay, but value is what 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.
Keeping investing simple by profiting from the products and/or services you personally use through undervalued high-quality dividend growth stocks is about as effective as it gets.
Of course, being able to spot undervaluation presumes one already knows how valuation works.
If you don’t already know, no worries.
Lesson 11: Valuation, written by fellow contributor Dave Van Knapp, lays out the whole concept of valuation in easy-to-understand terminology and even provides a valuation template you can use all on your own.
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…
Mondelez International Inc. (MDLZ)
Mondelez International Inc. (MDLZ) is an American multinational confectionery, snack food, and beverage company.
Founded in 2012, but with certain corporate roots dating back to 1923, Mondelez is now a $77 billion (by market cap) confectionary and snack might that employs just over 90,000 people.
The company reports results across four geographic segments: Europe, 35% of FY 2023 revenue; America, 31%; Asia, Middle East & Africa, 20%; and Latin America, 14%.
Developed markets account for 61% of sales, while the remainder comes from developing markets.
FY 2023 revenue can also be broken down by product category: Biscuits and Baked Snacks, 49%; Chocolate, 30%; Gum and Candy, 12%; Beverages, 3%; and Cheese and Grocery, 6%.
Mondelez runs a very simple business model based on selling enjoyable snacks to billions of people all over the world.
These snacks benefit from three key points.
First, they’re enjoyable.
This invokes a desire to buy, along with a pleasurable response once consumed.
Second, they’re consumable.
They must be purchased again once consumed, creating recurring revenue.
Third, they’re sold under recognizable and powerful brands.
These brands create a sense of consistency, quality, and trust for the consumer.
Some of these brands include: Cadbury, Oreo, and Ritz (all of which are brands doing more than $1 billion in sales per year).
These brands have helped Mondelez to build market-leading positions.
Mondelez holds the #1 global position in biscuit, and #2 global position in chocolate.
Simply put, people love snacking.
Per the 2023 State of Snacking report, 88% of consumers snack daily, and 76% report longtime loyalty to specific brands.
When you combine a natural desire for a consumable product with immense brand power, you’re able to scale up and build a large and defendable business with visible and recurring revenue.
And this is what puts Mondelez in a position to continue growing its revenue, profit, and dividend for years to come.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Already, Mondelez has increased its dividend for 13 consecutive years.
While that might not seem all that long, this track record is as long as it possibly could be.
This dates back to the 2012 spin-off of Mondelez from its former parent company Kraft Foods Inc.
We can see that Mondelez has been a dividend grower right out of the gate (although it was a large and mature entity already, before it went independent).
The 10-year dividend growth rate is 11.6%, which is quite strong and well in excess of the inflation rate.
Better yet, Mondelez has been incredibly consistent with the dividend raises.
For reference, the five-year dividend growth rate is 10.4%, and the most recent dividend raise came in at 10.6%.
Mondelez reliably grows its dividend at a low-double-digit rate (usually somewhere between 10% and 11%).
It’s like clockwork.
And one gets to pair that LDD dividend growth with the stock’s starting yield of 3.3%.
It’s almost unbelievable to see this stock with a yield this high.
Outside of some kind of market crash, this stock typically offers a much lower yield (this yield is 110 basis points higher than its own five-year average).
To the contrary, we’re at all-time highs in the market, so that makes this yield that much more shocking.
Mondelez’s stock has taken a beating lately (which leads to me covering it today), causing the yield to rise as the price has fallen.
This stock beating has its roots in a few different concerns, which I’ll touch on, but the dividend remains on solid ground.
The payout ratio of 66.7% is elevated, and the dividend growth from here should be tied closely to business growth (there’s limited room for further payout ratio expansion), but the dividend is not in any danger whatsoever.
I see a lot to like here.
You get a 3%+ yield, along with a clear commitment to the dividend and the growth of it.
Revenue and Earnings Growth
As much as there is to like, though, many of the metrics above are based on past results.
However, investors care much more about what future results will be, as the capital of today gets risked for the rewards of tomorrow.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will be of great aid when the time comes 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.
And I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this manner should give us the information we need to build a case for where the business might be going from here.
Mondelez advanced its revenue from $34.2 billion in FY 2014 to $36 billion in FY 2023.
This is a compound annual growth rate of 0.6%.
On the face of it, this is disappointing.
However, there’s some context behind the slow top-line growth.
Mondelez has been busy shifting and optimizing its portfolio over the last decade, attempting to concentrate it on faster-growing, more profitable snack foods.
On one hand, this included divestitures, such as the recent sale of its developed market gum business to Perfetti Van Melle Group for $1.4 billion.
On the other hand, Mondelez has made a number of strategic acquisitions, including the purchase of Clif Bar & Company in 2022 for approximately $2.9 billion.
This has led to a lumpiness in revenue, making it difficult to get a read on the true growth trajectory.
I’ll note that revenue did drop precipitously after FY 2014, and stayed there for a few years, but it has since increased by 39.2% since FY 2019 alone.
Meantime, earnings per share grew from $1.28 to $3.62 over this 10-year period, which is a CAGR of 12.2%.
Very nice.
That’s what we want to see.
Net margin has just about doubled since FY 2014, indicating that the portfolio moves have been wise and position the business better.
At the same time as the portfolio reconstruction, Mondelez has been regularly repurchasing its own shares.
The outstanding share count has been reduced by almost 20% over this 10-year period.
The management team has been prudent, moving the business toward in-demand products with more growth and better profitability.
We can also see how well (nearly exactly) EPS and dividend growth line up over the last decade.
That shows deft control by management and a sustainable dividend growth track.
Looking forward, CFRA sees Mondelez compounding its EPS at an annual rate of 9% over the next three years.
This would be lower than what transpired over the prior decade, but I think a 9% EPS CAGR, in this environment would be a win.
Circling back around to the concerns I quickly brought up earlier, Mondelez has been facing a slew of headwinds over the last several years.
Inflation has forced the business to raise prices and challenge volumes, with this inflation felt most acutely in the prices of cocoa (which have skyrocketed).
Because of brand power, Mondelez can push price.
But it can only take it so far.
CFRA touches on this balancing act here: “…[Mondelez] will need to pass on higher input costs (most notably cocoa) to its customers. Volumes will likely be volatile in Europe as [Mondelez] negotiates prices with customers in this region. We also see the risk of rising elasticity levels, especially among low-income households that are more concerned about higher prices.”
In addition, the rise of GLP-1 drugs, which can curb appetites for snacks, have only added to Mondelez’s woes.
But CFRA points to the stability of the business model, the pricing power, its ability to take out overhead (to combat higher input costs and protect margins), its exposure to fast-growing geographic markets and product categories, and buybacks.
Overall, I like where CFRA is at on this one.
I’m willing to take the 9% number as the base case for near-term EPS growth.
That would set the dividend up for something pretty similar.
If one can get a 3%+ yield and ~9% EPS/dividend growth, that sets things up nicely for a ~12% annualized total return, assuming no major changes in the valuation.
And seeing as how various multiples are at multiyear lows right now, there could actually be further upside from a normalization of the valuation.
All that from a predictable, stable snack food company.
Awfully nice.
Financial Position
Moving over to the balance sheet, Mondelez has a good financial position.
The long-term debt/equity ratio is 0.6, while the interest coverage ratio is over 12.
Mondelez has about $17 billion in L-T debt on its balance sheet, which isn’t egregious at all for a company of this size.
I wouldn’t mind seeing less leverage, but this balance sheet doesn’t concern me at all.
Profitability is respectable.
Return on equity has averaged 14.4% over the last five years, while net margin has averaged 13.3%.
ROIC is routinely sitting near 10%.
I’d like to see even higher returns on capital, but Mondelez is doing well for itself.
I’ll also note that returns on capital were lower and lumpier a decade ago, so there’s been a smoothing and upgrade that’s occurred here.
It’s pretty clear to me that Mondelez is running a great business, supported by beloved brands.
And with economies of scale, a global distribution network, brand recognition, and pricing power, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Regulation, litigation, and competition are omnipresent risks in every industry.
Competition, in particular is a key risk, as this space is notoriously competitive.
Input costs, such as raw materials, are volatile and have recently been a lot higher.
Being a global enterprise, Mondelez has exposure to geopolitics and currency exchange rates.
There’s some exposure to macroeconomics, and a recession could cause consumers to pull back on discretionary snack food purchases.
The rise of GLP-1 drugs are a new risk and pose a threat to demand for snack foods.
This business has historically had a pretty low risk profile, but inflation and GLP-1s are raising the uncertainty.
However, with the stock sitting near a five-year low after a recent 25% selloff, I think the valuation is pricing in a lot more risk than ever before…
Valuation
The stock is trading hands for a P/E ratio of 20.
This is well below its own five-year average of 22.7.
The sales multiple of 2.2 is also far off of its own five-year average of 3.
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%.
This is a growth number that I tend to rely on when dealing with mature consumer businesses.
Based on recent dividend raises (in the 10%+ area), along with the near-term expectation for EPS growth (9%/year), a 7% dividend growth rate seems extremely achievable.
It actually leans on the conservative side, but I do like erring on the side of caution (especially with current headwinds).
The DDM analysis gives me a fair value of $67.05.
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.
Even with a cautious model that assumes less growth, the stock still 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 MDLZ as a 5-star stock, with a fair value estimate of $75.00.
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 MDLZ as a 3-star “HOLD”, with a 12-month target price of $72.00.
I came out low, but we all agree that the current pricing is too pessimistic. Averaging the three numbers out gives us a final valuation of $71.35, which would indicate the stock is possibly 21% undervalued.
Bottom line: Mondelez International Inc. (MDLZ) is a great business that owns some of the best snack food brands in the world. Consistent growth, respectable returns on capital, and not too much leverage. Although risks are rising, the stock’s selloff seems to be pricing in more than what’s necessary. With a market-beating yield, double-digit dividend growth, a sustainable payout ratio, more than 10 consecutive years of dividend increases, and the potential that shares are 21% undervalued, long-term dividend growth investors looking for a sleep-well-at-night idea have a prime candidate on their hands here.
-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 MDLZ’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 66. 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, MDLZ’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
Disclosure: I’m long MDLZ.
