One of my favorite “hacks” in life is investing.
Investing makes life so much easier.
When you have more money, you have more freedom, options, and agency.
Well, investing, by its very nature, tends to lead to a lot more money (and all of its related benefits).
And this is just in general terms.
If we want to be specific, we can make investing even more powerful.
A good example of this is the dividend growth investing strategy.
This strategy is all about buying and holding shares in high-quality businesses rewarding shareholders with safe, growing dividends.
You can find many examples by perusing the Dividend Champions, Contenders, and Challengers list.
This list has invaluable information on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
Because it takes rising profits to fund rising dividends, a long track record of steadily rising dividends tells you a lot about a business right off the bat.
Basically, this strategy almost automatically funnels you right into some of the world’s best businesses, and it sets you up with gobs of growing passive dividend income you can use to fund your life with (making life way, way easier).
That’s my real-money portfolio, and it generates enough five-figure passive dividend income for me to live off of.
It’s made my life so much easier that I was able to quit my job and retire in my early 30s.
My Early Retirement Blueprint goes into detail about how that happened.
As powerful as this strategy can be, valuation at the time of investment is a critical component.
While 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.
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.
Buying high-quality dividend growth stocks at attractive valuations, then holding for the long term, is one of the most powerful hacks in life you could possibly apply.
Of course, the preceding passage on valuation does assume that one already understands the basic ins and outs of that concept.
If that basic understanding isn’t already in place, be sure to give Lesson 11: Valuation a read.
Put together by fellow contributor Dave Van Knapp, it explains valuation using basic terms and also provides an easy-to-use valuation template that can help you to estimate the fair value of almost any business 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…
Monolithic Power Systems Inc. (MPWR) is a US-based global company that provides high-performance, semiconductor-based power management solutions.
Founded in 1997, Monolithic Power is now a $33 billion (by market cap) chip dominator that employs more than 3,000 people.
The US is the largest single geographic market for the company, accounting for 37% of revenue; various international markets (particularly China, at 35%) account for the majority/remainder of revenue.
Monolithic Power specializes in power management solutions by designing, developing, and marketing proprietary, advanced analog, and mixed-signal semiconductors.
It’s important to note that Monolithic Power employs a fabless model, allowing the firm to concentrate on its engineering/design prowess.
The company takes its proprietary designs and then works with leading semiconductor manufacturers to produce high-performance power management integrated circuits (ICs) for a variety of electronic products and end markets across automotive, communications, computing, industrial, etc.
Essentially, the company’s aim is to reduce energy consumption in end systems.
With rising demand for all kinds of technologies that are increasingly hungry for energy, reducing energy consumption across the board is vital for manufacturers.
It’s all about maximizing technology while simultaneously minimizing energy consumption.
This puts Monolithic Power in the right place, at the right time.
The company has been incredibly successful over the years, leveraging its portfolio of over 4,000 products to capture and maintain leading positions in technology and power management.
Yet, with the world becoming increasingly technological in almost every facet, straining the world’s energy resources, Monolithic Power is in a great position to become even more successful over the coming years.
Monolithic Power has already grown its revenue, profit, and dividend at prolific rates, and the future looks extremely bright.
Dividend Growth, Growth Rate, Payout Ratio and Yield
To date, the company has increased its dividend for seven consecutive years.
And with a five-year dividend growth rate of 25.9%, what a start Monolithic Power is off to!
Also, there are no signs of any kind of material slowdown, as the most recent dividend raise (which was announced only weeks ago) was 24.8%.
Clearly, we’re talking about consistent 20%+ dividend growth here.
With the payout ratio at 44.2% (based on adjusted EPS for FY 2024), which is not high at all, there’s underlying support here for more sizable dividend raises over the coming years – especially with the business growing as fast as it is (which I’ll delve into soon).
The dividend growth is amazing, but the trade-off in this case is the yield.
Not enticing for income-oriented investors, sure.
But if you appreciate high-quality compounders, this yield is actually quite decent (many other fast-growing compounders out there offer even lower yields – often in the 0.2% to 0.5% range).
To this point, Monolithic Power’s stock itself usually offers a lower yield than this.
This 0.9% yield is 30 basis points higher than its own five-year average.
The abnormality, if I can call it that, is caused by the recent dividend raise coupled with the recent stock weakness (which is what led to me covering it now).
So the stock is giving you a higher-than-usual yield, and the dividend growth isn’t slowing.
In this way, the stock might just look better than it ever has.
Revenue and Earnings Growth
As great as it may look, though, many of these dividend metrics are looking backward.
However, investors must always be looking forward, as the capital of today ultimately 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 use 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.
Amalgamating the proven past with a future forecast in this manner should give us the information we need to gauge where the business could be going from here.
Monolithic Power moved its revenue from $333 million in FY 2015 to $2.2 billion in FY 2024.
That’s a compound annual growth rate of 23.5%.
Incredible.
That’s one of the fastest top-line growth rates I’ve ever come across.
And it’s not like this is just acquired growth, as Monolithic Power is expanding its portfolio, reach, and capabilities.
Meanwhile, earnings per share grew from $0.86 to $14.12 (adjusted) over this period, which is a CAGR of 36.5%.
This is highly, highly impressive.
World-class growth here.
We can also see that Monolithic Power has been able to afford 20%+ dividend growth by growing the business at a 20%+ rate.
Love it when it’s that simple (rather than “forcing” large dividend raises through by expanding the payout ratio).
Excess bottom-line growth was fueled by rapidly improving profitability, offsetting some modest dilution.
Looking forward, CFRA is projecting a 16% CAGR for Monolithic Power’s EPS over the next three years.
While that would be a great result for almost any business out there, this would represent a pretty significant drop in growth for Monolithic Power.
And I’m not even sure how to square this forecast, as CFRA uses glowing language to extol Monolithic Power’s prospects.
For example, there’s this passage: “[Monolithic Power] remains very early in penetrating the automotive market, and we see good long-term prospects for its infotainment, safety, and connectivity application products. We see potential growth within the Enterprise Data segment, now 31% of sales, which demonstrates the strong momentum that [Monolithic Power] is seeing from its GPU and AI accelerator customers, and we see further upside through 2026. We see capacity expansion plans supporting new product introductions and believe the company is poised to grow revenue even during cyclical corrections, which has been the case in prior cycles.”
This passage alone highlights Monolithic Power’s growing product/tech capabilities, expansion across new growth verticals, and what might almost amount to immunity to the cycles.
If that’s not glowing praise, I’m not sure what is.
There’s also this passage, touching on share gains: “We like improving trends across more cyclical markets. We believe [Monolithic Power] is also benefiting from content share gains in areas like autos and communications, given opportunities tied to ADAS/EVs and optical modules/routers.”
Finally, CFRA has this to say: “…[Monolithic Power] is one of the best growth stories/share-takers in the chip space…”
That pretty much sums it up.
It’s one of the highest-quality, fastest-growing businesses across the chip space, growing its capabilities, expanding across verticals, and taking share.
On the other hand, there’s that voice in the back of the head that questions how long can it all go on.
With that in mind, I’m willing to split the difference with CFRA here, balancing its near-term cautiousness against Monolithic Power’s longer-term demonstration of excellence.
But even if I do that, that still sets up Monolithic Power for 20%+ EPS and dividend growth over the coming years.
It’s more of the same – a high-quality compounder set to continue compounding at high rates.
While the current yield isn’t much to write home about, the total return story (which is, in my view, far more important anyway) here is amazing.
For reference, this stock’s 10-year CAGR (including reinvested dividends) is nearly 32%.
That would have turned a $1,000 investment a decade ago into $15,000 today.
That’s 15 times your money in 10 years.
Younger dividend growth investors who haven’t missed the yield trees for the return forest have done well with this name, and I don’t see why they can’t continue to do well for years to come.
Financial Position
Moving over to the balance sheet, Monolithic Power has a stellar financial position.
The company has no long-term debt.
It ended last fiscal year with nearly $900 million in cash and cash equivalents, amounting to roughly 3% of the market cap.
Cash was down a bit YOY, but that’s only because the company is executing buybacks in order to offset dilution.
The company has been mildly dilutive with its float over the last decade, which is a minor annoyance, but I’d note that the company’s founder, Michael Hsing, still runs the company as CEO and owns 2.1% of the company.
Hsing is incentivized to run this company to the best of his ability and avoid dilution (which dilutes his stake).
Profitability for the firm is excellent.
Return on equity has averaged 22.8% over the last five years, while net margin has averaged 20.9%.
ROIC also routinely comes in at north of 20%.
Very high returns on capital here, and Monolithic Power is doing high ROE without leverage.
And net margin has effectively doubled compared to where it was a decade ago.
This is a very impressive operation.
Fundamentally speaking, it’s one of the best businesses I’ve ever looked at.
And with economies of scale, R&D, IP, technological expertise, established relationships with installed components, and switching costs, 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.
The technology industry as a whole, and the analog space specifically, is extremely competitive, and Monolithic Power must continually stay ahead of the tech curve in order to remain competitive and viable.
The chip industry is historically cyclical, and most (if not all) of the company’s end markets are also cyclical.
A global footprint exposes Monolithic Power to geopolitics (especially in regard to China) and currency fluctuations.
Monolithic Power is heavily reliant on external foundries, particularly in Asia, which limits how much control the firm has over its own destiny.
The company’s high growth rates and high returns on capital will likely invite more competition to come in and try to eat the company’s lunch.
Modest dilution is a headwind.
I definitely see some risks here, but the firm’s quality (which is extremely high) overcomes a lot of risk.
Moreover, with the stock down nearly 30% from recent highs, more risk has already been priced in…
Valuation
The stock’s P/E ratio is 49.
That’s using adjusted EPS (GAAP EPS, which puts the P/E ratio much lower, was positively impacted by significant one-time events in FY 2024).
In absolute terms, that’s one of the highest P/E ratios to ever grace one of my reports.
However, when a company is growing this fast, it’s really not all that high.
Lined up against the 10-year EPS CAGR, that puts the PEG ratio at 1.4.
This is not egregious.
Also, this is a stock that typically commands a way higher earnings multiple.
Its five-year average P/E ratio is 73.1!
We are far lower than that.
I see Monolithic Power soon hitting $5.00/quarter in EPS, putting us at about 35 times that number on a forward-looking basis.
Relative to the growth and quality of the firm, that’s really not bad at all.
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, a 10-year dividend growth rate of 20%, and a long-term dividend growth rate of 8%.
I’m extrapolating out the demonstrated five-year dividend growth rate into the next decade, albeit at a lower rate (to account for the near-term forecast for slowing EPS growth).
Is this assumption wild?
I really don’t think so.
Monolithic Power just increased its dividend by almost 25% only weeks ago, which is well above the 20% in the model.
Now, that kind of growth does not persist forever.
And that’s why I’m assuming a drop into a more reasonable high-single-digit growth rate after a decade of outsized growth.
If one doesn’t think Monolithic Power can grow its dividend at a high-teens rate (or better) over the next decade, this idea doesn’t make a lot of sense.
But I just don’t see anything to indicate that the business can’t do that.
The DDM analysis gives me a fair value of $908.26.
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 think the valuation looks more favorable than it has in a long time after the recent ~30% drop in price.
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 MPWR as a 3-star stock, with a fair value estimate of $760.00.
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 MPWR as a 3-star “HOLD”, with a 12-month target price of $800.00.
A bit of a spread, but we’re all in agreement that the current price is favorable. Averaging the three numbers out gives us a final valuation of $822.75, 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 MPWR’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 60. 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, MPWR’s dividend appears Borderline Safe with a moderate risk of being cut. Learn more about Dividend Safety Scores here.
Disclosure: I’m long MPWR.