We have a mind-boggling number of opportunities available to us these days.
This is especially true for those who live in the US.
The US has a massive job market replete with some of the world’s highest incomes.
Of course, income – even a high one – won’t get you everywhere.
Making a lot of money is a great start, but it’s what you save and invest that ultimately moves you ahead in life.
On this front, once again, it’s tough to beat the US.
That’s because the US is home to the world’s biggest and deepest capital markets.
There is no other stock market in the world with more and better choices than the US.
And we can narrow things down even further into what I think of as the “best of the best”.
I’m talking about high-quality businesses that generate ever-more profit and pay shareholders ever-larger dividends.
I’m talking about dividend growth investing, which is a long-term strategy that encourages buying and holding these high-quality businesses.
You can find hundreds of them by perusing the Dividend Champions, Contenders, and Challengers list, which has compiled invaluable information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
These are some of the best businesses in the world, evidenced by the terrific fundamentals and growing dividends.
Those growing dividends are the “proof in the profit pudding”, if you will.
Can’t fake cash.
Certainly can’t fake more and more cash.
This is why I’ve stuck to the dividend growth investing strategy since I started investing 15 years ago.
Sticking to it helped me to build 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 was able to live off of this passive dividend income ever since I retired in my early 30s.
How was I able to forego a steady paycheck at a young age?
The answer can be found in my Early Retirement Blueprint.
Now, business quality is very important.
But valuation at the time of investment is, arguably, just as important.
That’s because price is only what you pay, but 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.
For all of the opportunities out in front of you, at least when it comes to investing, undervalued high-quality dividend growth stocks must rank pretty close to the top of the list.
Being able to spot undervaluation does, of course, first require one to understand how valuation works.
Well, that’s where Lesson 11: Valuation comes in.
Written by fellow contributor Dave Van Knapp, it describes (using simple terminology) how to go about valuing 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…
Lincoln Electric Holdings Inc. (LECO)
Lincoln Electric Holdings Inc. (LECO) is a US-based global manufacturer of welding products.
Founded in 1895, Lincoln Electric is now a $10 billion (by market cap) welding products leader that employs approximately 12,000 people.
The company reports results across three segments: Americas Welding, 64% of FY 2024 sales; International Welding, 23%; and Harris Products Group (the company’s retail channel), 13%.
Lincoln Electric is one of the world’s foremost manufacturers of equipment and consumables for the welding industry.
Products sold by the company include: arc-welding solutions, consumable electrodes, fume extraction equipment, and plasma and oxy-fuel cutting systems.
These products are manufactured in the company’s 70 facilities located across 20 countries and then distributed to more than 160 countries worldwide.
End markets are extremely varied and include the likes of automotive, construction, and shipbuilding.
The client base is extremely diversified, with no one client accounting for more than 10% of revenue.
Many of our everyday products cannot be manufactured without the type of welding products Lincoln Electric manufactures and provides its users, which creates a sort of necessity for the business.
Over the last 130 years, Lincoln Electric has built itself a commanding share of market in the welding industry, leaning on its brand power and recognition for durable and reliable equipment and consumables.
Regarding that latter point, this is an important distinction.
Over half of the company’s sales are related to consumables (such as filler metals).
That’s huge.
What this means is, Lincoln Electric is taking advantage of the old “razor and blade” business model, whereby equipment requires an ongoing stream of “refills” after initial usage.
This creates steady repeat business and a high degree of revenue visibility for the company, since equipment can be rendered useless without the consumables portion.
And it locks in “sticky” customers by matching consumables to equipment, creating switching costs.
This strategy has worked very successfully for more than a century.
And I don’t see any reason why it won’t continue to work for the next century, leading to growth across the company’s revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Already, the company has increased its dividend for 30 consecutive years.
If the stock were in the S&P 500, it’d qualify to be a Dividend Aristocrat.
Nonetheless, the dividend growth track record is mighty impressive.
Its 10-year dividend growth rate is 11.9%.
Fantastic.
If we zoom in a bit, its three-year dividend growth rate is 11.7% – lining up very nicely and showing incredible consistency.
Now, unsurprisingly, the stock doesn’t offer a high yield.
You’ll almost never get a high yield when the growth rate is this high.
Still, the stock’s market-beating 1.7% yield is quite respectable.
This yield is also 20 basis points higher than its own five-year average, indicting some possible dislocation.
Again, not a huge yield.
But it’s a bit better than it usually is.
Besides, high-quality compounders like this offer more value in the growth and total return than the current yield (and those dividend raises really add up over time).
With a payout ratio of 36.8%, the fast rate of dividend growth appears poised to persist.
This isn’t a prime candidate for income-oriented investors who might be older and closer to retirement, but younger dividend growth investors who are able to lean into the power of long-term compounding could have a very interesting contender on their hands with this one.
Revenue and Earnings Growth
As interesting as it may be, though, many of the dividend metrics I just laid out are based on what’s happened in the past.
However, investors be thinking about the future, 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 definitely be of use when estimating 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.
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 a solid base from which to determine where the business might be going from here.
Lincoln Electric moved its revenue from $2.5 billion in FY 2015 to $4.0 billion in FY 2024.
That’s a compound annual growth rate of 5.4%.
Solid.
For a 130-year-old company to compound its top line at more than 5%/year, that requires doing the right things all the time.
Meantime, earnings per share grew from $1.70 to $8.15 over this period, which is a CAGR of 19%.
As amazing as this is, it’s not an accurate reflection of Lincoln Electric’s true growth profile.
The business is decently steady, but EPS can be a bit lumpy.
Growth comes in spurts.
If we advance just one year and look at the nine-year EPS CAGR, it drops to 13.7%.
Still terrific.
Just not quite as terrific as that first number.
Regardless, we can see plenty of excess bottom-line growth.
Why?
First, Lincoln Electric has been a relentless repurchaser of its own shares.
Second, profitability has greatly expanded over the last decade (which I’ll touch on later).
On that first point, the outstanding share count has been reduced by nearly 25% over the preceding decade.
Massive.
Looking forward, CFRA believes that Lincoln Electric will grow its EPS at a CAGR of 6% over the next three years.
There is some cyclicality in the business.
Like I said, growth can be bumpy, and Lincoln Electric has had flattish EPS growth over the last couple of years.
CFRA touches on this: “We believe that demand will recover in 2025 following a stretch of destocking activity, informing our outlook for a return to sales expansion over the next year.”
Also: “More recently, demand has faced a slump under higher rates as constrictive monetary policy contributes to a greater degree of caution from customers.”
On a forward-looking basis, though, I see reasons to be optimistic.
Following up on that last statement, CRA adds: “Soft sales performance should give way to recovery in 2025 as eased monetary policy lends to stronger spend across end markets, in our view.”
And this is just the very near term.
Over longer periods of time, Lincoln Electric is a proven winner.
CFRA notes: “In the longer term, we see a customer base with aging fleets, a need for infrastructure-related welding equipment, labor shortages, and a higher need for maintenance and repair, which are all positive catalysts for [Lincoln Electric] customer engagement and retention. We think [Lincoln Electric] has solid execution in offsetting higher raw material and freight costs by leveraging pricing actions, improved operational efficiencies, and cost management.”
Music to my ears, quite frankly.
This company is extremely friendly to shareholders, with consistent buybacks, intelligent acquisitions, and dividend raises.
It’s a well-run enterprise set to grow nicely through the cycles.
While I acknowledge the next year or two could result in just that MSD EPS growth, I think long-term growth is likely closer to a HSD-LDD mark.
And that would open things up for continued LDD dividend growth.
That squares up with the demonstrated 10-year dividend growth rate, which is what I’d be roughly penciling in over the next decade.
When adding in the dividend/yield, that could be setting up shareholders for a low-teens type of annualized total return (the stock’s 10-year all-in CAGR, including reinvested dividends is nearly 13%, for perspective).
In my view, this is a high-quality compounder that will almost certainly compound at a very satisfactory clip over the next decade or so.
Financial Position
Moving over to the balance sheet, Lincoln Electric has a very good financial position.
The long-term debt/equity ratio is 0.9, while the interest coverage ratio is just under 15.
Its credit ratings as a long-term issuer are well into investment-grade territory: AA, Fitch, AA, S&P.
No problems here whatsoever.
Profitability is wonderful.
Return on equity has averaged 38.2% over the last five years, while net margin has averaged 10.7%.
ROE isn’t overly juiced by the balance sheet, and ROIC is routinely over 20%.
Also, the improvement in this department has been remarkable.
ROE was routinely below 30% if you go back a decade, and net margin was often in a mid-single-digit range.
Lincoln Electric is a terrific business.
And with economies of scale, switching costs, brand power, leading market share, a large installed base, R&D, and IP, 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.
Competition, in particular, is a risk here, as Lincoln Electric’s few large competitors are capable and fierce.
The company is exposed to inherently cyclical end markets, making the business itself inherently cyclical.
Any major contraction in the US/global economy would likely reduce demand for activity and, thus, Lincoln Electric’s products.
Being a global company, it’s exposed to geopolitics and currency exchange rates.
The company is acquisitive, introducing risks around capital allocation and execution/integration.
Input costs around raw materials can vary wildly.
Overall, I don’t see this as a particularly risky business.
And the valuation may be pricing in more risk than necessary, offering up a chance to buy a high-quality business at a better-than-fair price…
Valuation
The stock is trading hands for a P/E ratio of 21.6.
While not all that low in absolute terms, this is attractive relative to its own five-year average of 24.7.
In addition, the P/CF ratio of 18.9, which is almost exactly in line with its own five-year average, is not at egregious at all for a business of this quality.
And the yield, as noted earlier, is slightly 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 11%, and a long-term dividend growth rate of 8%.
Nothing complicated here.
I’m basically extrapolating out the demonstrated 10-year dividend growth into the coming decade, which I think is a very reasonable assumption to make when you circle back around to the company’s overall near-term and long-term growth profile.
I’m then backing that down into a high-single-digit range, which isn’t a stretch for a business as great as Lincoln Electric; after all, the company is already 130 years into operation and just finished the last decade with an 11%+ dividend growth rate.
If anything, I’m probably being a bit conservative here, but I’d rather err on the side of caution.
The DDM analysis gives me a fair value of $208.89.
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.
In my view, the stock is inexpensive relative to its quality and value.
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 LECO as a 3-star stock, with a fair value estimate of $197.00.
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 LECO as a 3-star “HOLD”, with a 12-month target price of $225.00.
I’m almost exactly in the middle this time around. Averaging the three numbers out gives us a final valuation of $210.30, which which would indicate the stock is possibly 16% undervalued.
Bottom line: Lincoln Electric Holdings Inc. (LECO) is a high-quality company, generating gobs of growth and high returns on capital with its market-leading positioning and brand power. It’s been highly successful for 130 years, and I don’t see anything changing on this front. With a market-beating yield, a moderate payout ratio, double-digit dividend growth, 30 consecutive years of dividend increases, and the potential that shares are 16% undervalued, long-term dividend growth investors looking to buy a wonderful business at a better-than-fair price should seriously consider this idea.
-Jason Fieber
Note from D&I: How safe is LECO’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 98. 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, LECO’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 LECO.
