What’s the greatest thing about investing?
Tough to say.
I think there are many candidates for the top of the list.
But if I had to really narrow it down, benefiting from the long-term power of compounding comes to mind.
Compounding over a long period of time has life-changing power, and it makes long-term investing a venture that you almost can’t lose at.
This can’t-lose nature is reinforced when one sticks purely to high-quality businesses.
And that’s something that one almost can’t avoid when they implement the dividend growth investing strategy – a long-term investment strategy that advocates buying and holding shares in wonderful businesses paying safe, growing dividends to shareholders.
Because it takes a high-quality business to generate the ever-larger profit necessary to sustain ever-bigger dividends, this strategy often funnels investors right into some of the world’s best businesses (which are some of the world’s best compounding machines).
The Dividend Champions, Contenders, and Challengers list, which has data on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years, is a treasure trove of these very businesses.
I’ve been personally using the dividend growth investing strategy for 15 years, allowing it to 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.
In fact, I’ve been able to live off of dividend income ever since I quit my day job and retired in my early 30s.
If you’re interested in finding out how that’s possible, check out my Early Retirement Blueprint.
Now, as great as the dividend growth investing strategy is, it’s more involved than simply selecting the right businesses to invest in.
Investing at the right valuations is also key.
Whereas price tells you what you pay, value tells you 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.
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.
Benefiting from the long-term power of compounding might just be the very best thing about investing, and buying undervalued high-quality dividend growth stocks might just be the best way to tap into this power.
The whole concept of valuation, which I only briefly touched on, may seem daunting, but it’s really not.
If it seems like a lot to you, make sure to give Lesson 11: Valuation a read.
Written by fellow contributor Dave Van Knapp, it explains the ins and outs of valuation using simple 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…
NextEra Energy Inc. (NEE)
NextEra Energy Inc. (NEE) is an American energy company.
Founded in 1925, NextEra Energy is now a $151 billion (by market cap) power utility major that employs approximately 17,000 people.
By market cap, this is the largest utility holding company in the US.
NextEra Energy reports results across three segments: Florida Power & Light, 69% of FY 2024 revenue; NextEra Energy Resources, 30%; and Corporate and Other, 1%.
FPL operates the largest electric utility business in Florida, providing electricity to over 12 million people across the state of Florida.
FPL’s energy mix is: 73% natural gas, 20% nuclear, 6% solar, and 1% other.
Based on electricity sales, FPL is the largest utility in the US.
Nearly 60% of FPL accounts are residential, while another ~33% are commercial.
NEER, NextEra Energy’s unregulated renewable energy subsidiary, is the world’s largest generator of renewable energy from the wind and sun, and it’s also a world leader in battery storage.
Whereas FPL is contained to Florida, NEER generates and sells power across the US (with more than 34 GW of generation capacity).
NextEra Energy is a special US utility holding company.
It offers investors a unique, best-of-both-worlds proposition.
FPL, which is about two thirds of the company, gives shareholders exposure to a high-quality regulated utility in a fast-growing, regulation-friendly state.
The traditional utility side of the business is a sleep-well-at-night, steady-eddy operation that takes in reliable revenue from customers that cannot live without electricity in a modern-day society.
But FPL cranks it up a notch because of Florida’s population growth (regulated power utilities are usually geographically limited to one area, which means their fortunes rise and fall with that area).
Between 2020 and 2024 alone, Florida is estimated to have gained nearly 2 million new residents.
Florida, the third-largest state in the US, is one of the very best areas in the US in which to run a regulated utility.
The other one-third portion of the company, which is NEER, gives shareholders exposure to industry-leading renewables and the growth possibilities therein.
This additional upside potential, which comes via an unregulated model with less geographic constraints, is upside that no other large, regulated power utility company in the US can match.
NextEra Energy is successfully operating both an orthodox electric utility business and a renewable energy business – and it’s doing so at unequaled scale.
This combination is the best of the old and the new.
NextEra Energy is appropriately named, as it’s preparing for the next era of energy via its investments in and usage of newer forms of energy (such as solar and wind power generation, along with battery storage).
The world is moving toward energy forms that are, correctly or incorrectly, perceived to be cleaner and more sustainable for society.
Utility companies that can adapt to this change will be in the best position to not only survive but thrive under a new energy paradigm in the future.
However, NextEra Energy is intelligently grounded in today’s reality, using proven resources (such as natural gas) to generate electricity for customers who require reliable power 24/7 right now.
NextEra Energy has taken an all-of-the-above approach to energy, and it’s been highly successful for the company and it shareholders.
This approach has led to consistent growth across revenue, profit, and the dividend, which I believe will continue for years to come.
Dividend Growth, Growth Rate, Payout Ratio and Yield
To date, the company has increased its dividend for 31 consecutive years.
That’s an impressive track record that qualifies the company for its status as an esteemed Dividend Aristocrat.
In fact, NextEra Energy is one of only three US power utility companies that is a Dividend Aristocrat.
Its 10-year dividend growth rate is 11%, which is really strong for a utility.
If you take a look across the power utility landscape, you’ll notice that most of the dividend growth rates are in the mid-single-digit range.
Double-digit dividend growth from a business model like this is almost unheard of, underscoring the uniqueness and growth potential of the company (which I highlighted just moments ago).
Better yet, NextEra Energy has been extremely consistent with that double-digit dividend growth.
Its five-year dividend growth rate is 10.5%, and the most recent dividend raise came in at 10%.
Moreover, the company’s guidance is calling for more.
Per the Q4 FY 2024 report: “NextEra Energy also continues to expect to grow its dividends per share at a roughly 10% rate per year through at least 2026, off a 2024 base.”
What makes this even more incredible is the fact that the stock still offers a utility-like yield of 3.1%.
Sure, that’s not the highest yield you can get in the utility space, but it’s not totally off base.
And when you’re pairing that 3%+ starting yield with double-digit dividend growth, it’s obvious to see how appealing that combination is.
By the way, this market-beating yield is 90 basis points higher than its own five-year average, indicating the unusualness of this yield (relative to what the stock typically offers) and the possibility of some serious undervaluation.
With a payout ratio of 66.1%, NextEra Energy’s dividend appears to be quite secure.
The dividend metrics out of this Dividend Aristocrat are great.
Revenue and Earnings Growth
As great as they are, though, many of these numbers are looking backward.
However, investors must always be looking forward, as today’s capital gets risked for tomorrow’s rewards.
As such, I’ll now build out a forward-looking growth trajectory for the business, which will instrumental for the valuation process.
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.
Lining up the proven past with a future forecast in this manner should give us what we need to roughly gauge where the business could be going from here.
NextEra Energy has moved its revenue from $17.5 billion in FY 2015 to $24.8 billion in FY 2024.
That’s a compound annual growth rate of 4%.
Solid top-line growth here for a power utility.
Meantime, earnings per share grew from $1.51 to $3.37 over this period, which is a CAGR of 9.3%.
Again, super impressive bottom-line growth when considering the business model and what the competition is able to do – especially in the light of the steady dilution (power utilities frequently turn to equity and debt to fund growth projects).
Looking forward, CFRA believes that NextEra Energy will compound its EPS at an annual rate of 9% over the next three years.
Clearly, CFRA is expecting more of the same.
This forecast is very close to what NextEra Energy made good on over the last decade.
This forecast is also close to what management has been guiding dividend growth at (with that guidance referenced above).
NextEra Energy’s management also includes near-term EPS guidance.
For FY 2027, top-end adjusted EPS guidance calls for $4.32.
Off of the FY 2024 base, that’s a CAGR of 8% from here to there.
So that’s in the ballpark of where CFRA is at.
This passage from CFRA really hits on what makes this utility special: “We think [NextEra Energy’s peer-premium valuation reflects stronger EPS and dividend growth potential, supported by superior balance sheet health (debt/ capitalization and leverage below peer averages) and a favorable regulatory environment for Florida utilities, in our view. A falling rate environment could help renewables developers like NEER see their financing difficulties ease. We expect long-term tailwinds for NEER’s renewables backlog (estimated at over 25 GW at year-end 2024) and capex opportunities, such as solar investment in Florida, underpinned by clean energy tax credits from the IRA and increased U.S. power demand from AI and data center growth. Given the historically constructive Florida service territory, as well as [NextEra Energy]’s consistent capital investments and strong customer growth, we anticipate a favorable outcome for FPL’s next multi-year rate plan.”
It’s just tailwind after tailwind.
Whether you’re at 8% or 9% here isn’t the point; the point is that NextEra Energy is clearly poised to grow its EPS and dividend at a high-single-digit rate over the foreseeable future.
Long-term investing is about probabilities, not precision.
And when you’re getting a 3%+ yield and 8%+ dividend growth to back it up, all from a high-quality utility providing power that consumers cannot live without, it’s awfully difficult to dislike that.
Financial Position
Moving over to the balance sheet, the company has a fairly standard financial position for a power utility.
The long-term debt/equity ratio is 1.2, while the interest coverage ratio is over 3.
NextEra Energy’s balance sheet represents the one area of the company that isn’t special.
I see the balance sheet as neither great nor terrible.
This looks pretty much like any other power utility’s balance sheet.
Profitability is outstanding.
Return on equity has averaged 11.9% over the last five years, while net margin has averaged 22.2%.
Very few power utilities can come anywhere close to matching NextEra Energy’s profitability, and I think the high ROE (which is a function of how much NextEra Energy is allowed to recoup from its investments through rate plans) illustrates just how favorable its Florida jurisdiction is.
NextEra Energy is, in almost every way, a superior power utility business.
And with economies of scale, a geographic monopoly over its FPL territory, less geographic constraints in its NEER business, and a constructive regulatory situation that just about guarantees some level of profit, 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.
Regulation is a double-edged sword.
Regulators allow for utilities to make a reasonable profit, where profit scales with costs, putting a profit floor in place.
On the flip side, because electricity is necessary and there’s often only one power provider in any one geographic area, regulators put a profit ceiling in place by limiting the rates a utility can charge.
This is a rare industry in which competition at a local level doesn’t exist, as NextEra Energy runs local monopolies across its territory.
That said, customers could become future competitors by generating power at the site of consumption (through solar installations).
NextEra Energy’s FPL is captive to the regulatory structure and population growth of Florida, but Florida’s positive migration trends and favorable regulatory outcomes bode well.
On the regulation front, Morningstar states: “[FPL] enjoys above-average returns on equity, forward-looking rate adjustments, and automatic general base-rate adjustments for investments upon completion. We expect future returns to be… above most other utilities.”
NextEra Energy has exposure to nuclear and the risks therein.
Natural disaster risk is also present, particularly considering Florida’s vulnerability to hurricanes.
The economics regarding renewables are still not certain, and it remains to be seen how successful NEER will ultimately be.
While most of these risks are fairly common across the power utility space, NextEra Energy is anything but a commonplace utility.
And with the valuation as low as it is, the valuation also does not appear to be commonplace…
Valuation
The stock is trading hands right now for a P/E ratio of 21.
For a random power utility, that’s a bit on the high side.
However, for what is, arguably, the very best power utility company in the US, this is not high at all.
Indeed, this stock usually commands a healthy premium (as it should), and this P/E ratio of 21 is far below the stock’s own five-year average P/E ratio of 29.9.
Now, to be fair, 30 times earnings for a utility is heavy, and so it’s not surprising to see some compression.
But the stock is now trading roughly in line with a lot of “plain Jane” names in the space, which would indicate the compression has gone too far.
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 7.5%.
This dividend growth rate is at the higher end of what I allow for, which is something I’d usually be reluctant to use for a power utility, but NextEra Energy is no ordinary utility.
I’ve used this 7.5% mark before for NextEra Energy, and I feel good about sticking with it.
The data is clear: NextEra Energy has been incredibly consistent with its dividend growth, typically coming in at the 10% mark.
NextEra Energy’s management is guiding for more 10% (roughly) annual dividend growth for the next few years, lining up pretty close to the near-term forecast for EPS growth.
In the end, I see NextEra Energy making good on its guidance and handing out ~10% dividend raises over the next few years, which would be in excess of where my model is at, but this is a long-term model that bakes in the eventual slowing of growth.
There will be some faster, front-loaded dividend growth over the next three years, but I’m confident this will slow and settle into a high-single-digit range (which would still be excellent for a power utility company).
The DDM analysis gives me a fair value of $97.61.
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.
This might not just be the best power utility company in the US but also the best utility stock in the market (based on how much undervaluation could be present).
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 NEE as a 3-star stock, with a fair value estimate of $73.00.
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 NEE as a 4-star “BUY”, with a 12-month target price of $84.00.
I came out on the high end, in spite of near-term dividend growth likely exceeding my model by a large margin. Averaging the three numbers out gives us a final valuation of $84.87, which would indicate the stock is possibly 17% undervalued.
Bottom line: NextEra Energy Inc. (NEE) is in many ways the very best power utility company in the US. The best-of-both-worlds approach positions the firm extremely well. It has a regulated, sleep-well-at-night power utility business in Florida, which is a state with positive migration and a favorable regulatory environment. Simultaneously, it operates the largest renewables business in the world, benefiting from industry-leading scale and less geographic constraints. With a market-beating yield, a reasonable payout ratio, double-digit dividend growth, more than 30 consecutive years of dividend increases, and the potential that shares are 17% undervalued, this might just be the best long-term investment opportunity across the utility space for dividend growth investors.
-Jason Fieber
Note from D&I: How safe is NEE’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 90. 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, NEE’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’m long NEE.