There are countless investment strategies out there that one can adapt and follow.
And there are many different asset types that one can allocate capital to and accumulate.
So how do we filter down into what’s best?
Well, what’s “best” is somewhat subjective, determined by one’s own objective, temperament, etc.
But I think a useful start is the Hippocratic Oath.
Although it has nothing to do with investing, the way in which it’s often boiled down into “do no harm” has a lot of relevance.
I think that approach of “doing no harm” to one’s money is a fantastic way to think about investing.
And when applying this thinking, the strategy that first comes to mind is dividend growth investing.
This is a long-term investment strategy whereby one buys and holds shares in world-class businesses that are rewarding their shareholders with ever-larger dividends.
It’s a simple philosophy: It takes a special kind of business to be able to generate the ever-more profit necessary to afford ever-larger dividends, and those ever-larger dividends aren’t just a great quality identifier but also a fantastic source of rising passive income to live off.
You can see many such special businesses by taking a look at the Dividend Champions, Contenders, and Challengers list – a compilation of hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
The reason why this strategy fits a “do no harm” mentality is because it’s hard to go wrong with investing in world-class businesses that are so proven and profitable that they can afford to pay generous and rising cash dividends.
I’ve done my best to avoid harm over the last 15 years of investing, sticking to dividend growth investing 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.
This passive dividend income has been enough to cover my life since I was put in the very fortunate position of being able to retire in my early 30s.
How I ended up in this position is shared in my Early Retirement Blueprint.
Now, another aspect of doing no harm comes down to avoiding drastically overpaying for your stocks.
And that’s a matter of valuation.
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.
If we think about successful long-term investing in terms of “doing no harm”, buying undervalued high-quality dividend growth stocks is a great approach toward that end.
All that said, being able to spot undervaluation first requires one to understand how valuation works.
And that’s why Lesson 11: Valuation is such a worthwhile read.
Written by fellow contributor Dave Van Knapp, it explicitly describes the whole concept of valuation using simple terminology, and it even provides an easy-to-use valuation template you can avail yourself of.
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…
EOG Resources Inc. (EOG) is an American energy company that engages in hydrocarbon exploration and production.
Founded in 1999, EOG Resources is now a $62 billion (by market cap) O&G player that employs just over 3,000 people.
EOG Resources primarily operates across a number of US shale fields and basins, including Williston Basin, Powder River Basin, DJ Basin, Anadarko Basin, Barnett Shale, Permian Basin, Eagle Ford, Dorado, South Texas, Utica, and the Columbus Basin.
The company finished FY 2024 with net proved reserves at 4.7 billion barrels of oil equivalent (worth roughly 13 years of production), which increased by about 5.5% YOY.
Average daily production was just over 1 million boe/d in 2024 (up nearly 8%YOY).
On one hand, EOG Resources operates a commodity-based business, making it a price taker (not a price maker).
That’s the drawback.
However, if one can get past that sticking point, there’s a lot to like about investing in O&G, in general, and EOG Resources specifically.
I say that because this is a business that furnishes vital resources which are, ultimately, absolutely necessary in order to sustain modern-day life and society.
We quite literally cannot live life as we know it without these resources.
Everyday “conveniences” we take for granted – electricity, for example – just don’t work without hydrocarbons in our current setup across the world.
Beyond that, there is no modern-day human consumption without accompanying oil & gas consumption.
Consumerism, industry, and society combine to support a base level of demand for O&G.
While the world is slowly moving toward “cleaner” forms of energy that are more renewable, all of this is not yet enough – or even close to it – to meet basic needs.
Plus, this is a moving target on the demand side.
Technology in developed countries is requiring much more energy than before (see: AI).
Simultaneously, developing countries need more energy as they develop, which involves consuming more, improving the general standard of living for citizens, and building industries out.
Hydrocarbons as a major energy source may (and almost certainly will) vanish at some point in the distant future, so an investor who is only 20 years old may want to keep that in mind.
In the meantime, though, demand for hydrocarbons continues to rise.
Beyond that built-in, rising demand, the supply side of the equation looks better than it has in years.
The industry used to have a “drill, baby, drill” mantra, which prioritized maximizing production in order to drive higher revenues (even if it came at the expense of profitability).
But the industry has found religion in the last few years, focusing more on “cash flow production” rather than pure “hydrocarbon production”.
Low costs, rational production/competition, and the generation of free cash flow (which can be returned back to investors via buybacks and dividends) have been prioritized across the industry.
EOG Resources has been particularly emblematic of this, hammering its costs down to the minimum.
Morningstar highlights this: “In EOG’s case, leading well production allows EOG to enjoy some of the lowest cash operating costs in our US E&P coverage. In fact, since 2016, on a rolling quarterly basis, EOG’s cash operating costs are on average over 20% lower than its US E&P industry peer set.”
Costs down, shareholder rewards up.
Morningstar adds: “EOG’s capital allocation strategy sits somewhat alone relative to other US exploration and production players. While the consolidation bug has bitten its peers and the integrated majors, EOG principally focuses on organic exploration efforts. And, like other US E&P peers, EOG has embraced a capital allocation policy that emphasizes returning cash to shareholders, yet retains a willingness to invest in modest production growth. Finally, in an industry that overextended itself during the shale revolution, EOG pivoted sooner than most in becoming a low-cost provider. EOG’s enviable asset mix, including its leading position in the Delaware Basin, position the firm as a premier shale player with industry-leading returns on capital.”
The industry has gotten better, but EOG Resources has gotten especially better, and that’s leading to more revenue, profit, and dividends.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, as Morningstar just highlighted, there’s an emphasis on returning capital back to shareholders, and that shows up in the company’s eight consecutive years of dividend increases.
Its five-year dividend growth rate is 29.1%, which is incredible, although more recent dividend growth has been in a high-single-digit range (because of a severe drop in oil prices of late).
Still, that’s plenty of dividend growth when you layer that on top of the stock’s starting yield of 3.5%.
Worth noting is that this market-beating yield is 110 basis points higher than its own five-year average.
This headline yield doesn’t include the special dividends that EOG Resources intermittently pays.
If we take its special dividends from 2023, for instance, they added up to another 2.2% of yield by themselves – putting the all-in yield at 5.7%.
Even without the special dividends, a 3.5% yield is appealing against the clear longer-term trend of double-digit dividend growth.
And a payout ratio of only 36.2%, this dividend is very healthy and sustainable.
I see something to like for everyone.
You get yield, safety, and growth all in one package.
Revenue and Earnings Growth
As likable as these numbers may be, though, many of them are backward-looking in nature.
However, investors must always try to look forward, as the capital of today gets risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will come in handy when the time comes later 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.
I’ll then reveal a professional prognostication for near-term profit growth.
Amalgamating the proven past with a future forecast in this way should allow us to roughly gauge where the business could be going from here.
EOG Resources increased its revenue from $8.8 billion in FY 2015 to $23.7 billion in FY 2024.
That’s a compound annual growth rate of 11.6%.
That’s strong top-line growth for an O&G company.
This is in the same neighborhood as a great tech company, so it’s somewhat surprising.
Because EOG Resources took a GAAP loss for FY 2015, I’ll advance the comparison to FY 2017.
During this eight-year period, EOG Resources grew its earnings per share from $4.46 to $11.25, which is a CAGR of 14.1%.
Very, very strong growth out of EOG Resources.
I’m not sure one would assume double-digit top-line and bottom-line growth out of a commodity business, but that’s what we’re talking about here.
That said, it’s important to acknowledge how unusual this period has been.
It includes a profound amount of positive and impactful change across the industry.
With a lot of low-hanging fruit already picked, I would moderate my expectations from this point onward.
Looking forward, CFRA is projecting a 1% EPS CAGR for EOG Resources over the next three years.
There’s that moderation I was just mentioning, but this is more extreme than I’m thinking.
It’s an interesting forecast considering how positive CFRA seems to be about EOG Resources, noting its enthusiasm is: “…supported by EOG’s strong positions in key liquids-rich plays, strategic Dorado gas play near export markets, and expansion in Ohio Utica and Powder River Basin. The company’s early focus on returns over production and sustainable cost reductions (75% of 2020 cost savings) through innovation rather than temporary service cost cuts demonstrates operational excellence. While natural gas prices remain weak, EOG’s strategic management of Dorado positions it well for future LNG export growth.”
I think that last sentence offers key insight into the juxtaposition at play.
While the long-term outlook for EOG Resources remains incredibly bright, the near term is much more cloudy simply because of tough comps and much lower oil prices.
Since, as noted earlier, EOG Resources is a price taker, it’s dependent on oil prices.
And with oil on a ~20% slide over the last year, EOG Resources has consequences to face right now.
With that out of the way, though, its long-term positioning, which has been carefully crafted over several years, is brilliant.
I don’t take much issue with CFRA’s 1% short-term number, but I also construct long-term models for valuation.
Overall, I just don’t see much to indicate that EOG Resources will generate anything less than high-single-digit dividend growth over the many years ahead.
The supply-demand setup is too favorable, the payout ratio is too low, the cost structure is too good, and the emphasis on shareholder returns is too strong to think otherwise.
And you’re getting that on top of the 3.5% starting yield.
It’s tough not to be compelled by this.
Financial Position
Moving over to the balance sheet, EOG Resources has a fantastic financial position.
The long-term debt/equity ratio is 0.1, while the interest coverage ratio is over 50.
As terrific as these numbers are, they don’t fully convey just how good this balance sheet is.
That’s because the balance sheet is sitting on net cash.
This balance sheet is beautiful.
Profitability is extremely robust.
Return on equity has averaged 21.2% over the last five years, while net margin has averaged 21.6%.
It’s pretty extraordinary to see such high returns on capital out of an O&G company, and I think this speaks on how intelligently this company has been run.
If I were blindfolded and shown these fundamentals, I might think this were some kind of tech company.
Quite frankly, it’s a wonderful business.
And with economies of scale, low-cost operations, barriers to entry, and favorable acreage, 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, in particular, is a thorny issue in this industry, but more regulation can actually counterintuitively be a boon (by suppressing supply, thereby increasing commodity prices).
While the world still requires hydrocarbons for energy, there’s a risk over the very long run that renewable forms of energy will eventually displace oil & gas completely.
It’s a capital-intensive business model which is simultaneously highly cyclical.
Being a commodity business which is highly dependent on its underlying commodity pricing, EOG Resources is a price taker (not a price maker).
The company’s reserves must continually be added to so as not to risk running out of supply.
Fields naturally get depleted over time, and there is uncertainty regarding how much supply is left in the world.
The industry sees constant pressure from some environmental groups, which may result in negative goodwill across some parts of society.
I see risks worth seriously considering, but the quality of this business is also worth seriously considering.
And with the valuation being as low as it is, I just don’t think the wonderfulness of the business is being fully appreciated by the market…
Valuation
We’re looking at a P/E ratio of only 10.4 on the stock.
That’s less than half that of the broader market’s yield.
This is also quite a bit lower than the stock’s own five-year average yield of 12.2.
The P/CF ratio of 5.6, which is extremely undemanding on its own, is lower than its own five-year average of 6.1.
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 model circles back around to what I touched on earlier, which is that it’s difficult to see any future in which EOG Resources doesn’t grow its dividend at a high-single-digit rate (or better), although this is more of a long-term forecast that acknowledges the possibility of below-trend dividend growth over the next year or two.
Again, there’s simply too much working in the company’s favor.
Even with flattish EPS growth over the coming few quarters, the payout ratio can easily be expanded some.
While I wouldn’t necessarily expect special dividends to return any time soon, there’s enough yield and dividend growth here during depressed circumstances to make sense of the investment.
And during better times, we can see just how great EOG Resources can be at rewarding shareholders (reflected in the special dividends and double-digit dividend growth over the preceding five years).
I see a one-foot bar to step over here.
The DDM analysis gives me a fair value of $139.10.
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 just see a lot of value relative to the quality here.
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 EOG as a 4-star stock, with a fair value estimate of $131.00.
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 EOG as a 4-star “BUY”, with a 12-month target price of $127.00.
We’re all in a fairly tight range here. Averaging the three numbers out gives us a final valuation of $132.37, which would indicate the stock is possibly 16% undervalued.
-Jason Fieber
Note from D&I: How safe is EOG’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 82. 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, EOG’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 EOG.