Investing is simple but hard.

On one hand, the basic ins and outs of investing aren’t all that difficult to figure out.

On the other hand, actually executing on those ins and outs in the moment – and this is what matters most – can be extremely challenging.

This is largely because of how counterintuitive successful investing can be.

It often feels downright awful to deploy capital and invest precisely when it’s the very best time to do so.

I see this as a feature, not a bug.

But it can trip up a lot of people and cause them to fall into the ol’ “buy high, sell low” trap.

Avoiding this trap is key.

Toward that end, I think one strategy stands above the rest.

It’s dividend growth investing.

This is a long-term investment strategy involving buying and holding shares in high-quality businesses which pay shareholders safe, growing dividends.

See, growing dividends get funded by growing profits over time.

This funding mechanism helps one to avoid low-quality businesses that can’t grow.

And this rising passive cash flow keeps one in the game.

Plus, when you’re constantly receiving rising dividend income, you’re funded when the market drops and provides lots of buying opportunities.

You can find hundreds of stocks that qualify for this strategy by pulling up 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.

I’ve personally bought and held a number of these stocks over the years, using them to build the core of the FIRE Fund – my real-money portfolio which produces enough five-figure passive dividend income for me to live off of.

This passive dividend income has been enough for me to live off of since I was in the extremely fortunate position of being able to retire in my early 30s.

If you’re interested in finding out how such a thing is possible, make sure to give my Early Retirement Blueprint a read.

Another key feature of this strategy, which helps one to avoid the aforementioned trap of buying high and selling low, is its focus on valuation at the time of investment.

See, price is only what you pay, but value is ultimately 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.

Slowly and surely building a significant portfolio by regularly acquiring undervalued high-quality dividend growth stocks is a great way to execute on the simple ideas that work in long-term investing.

Now, the whole concept of valuation seems intimidating to the uninitiated.

Well, that’s where Lesson 11: Valuation can come in and help.

Written by fellow contributor Dave Van Knapp, it explains how valuation works and how to easily go about estimating the fair value of almost any dividend growth stock you’ll come 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…

UnitedHealth Group Inc. (UNH)

UnitedHealth Group Inc. (UNH) is a managed healthcare firm that provides health insurance, pharmacy benefit management, and care delivery to millions of clients.

Founded in 1974, UnitedHealth is now a $275 billion (by market cap) healthcare giant that employs 400,000 people.

The company reports results across two primary business segments: UnitedHealthcare, 54% of FY 2024 revenue; and Optum, 46%.

The largest business, UnitedHealthcare, primarily provides risk-based, fee-based health insurance (via UnitedHealth) to more than 50 million people globally.

There’s immense value in this service, as forgoing health insurance can lead to financial ruin in the event that a major health issue crops up (particularly in the US).

This service gives a client access to cost-effective health services within a specified network of care.

In addition, UnitedHealthcare provides supplemental Medicare insurance to seniors, as well as Medicaid management services for state governments.

The second business, Optum, is largely comprised of the conglomerate’s pharmacy benefit manager, OptumRx.

The PBM engages in drug price negotiation, the establishing of drug formularies, pharmacy network creation, and drug claim processing.

Optum, via the OptumHealth arm, also provides healthcare services to patients through networks of outpatient facilities.

As you can see, by owning a piece of the entire value chain, UnitedHealth is vertically integrated, managing upstream clients on the insurance side and downstream clients on the healthcare side.

This is an incredibly powerful flywheel, where each side of the business complements and reinforces the other.

Morningstar touches on this unique positioning: “Also, UnitedHealth’s leadership team, including current chair and CEO Stephen Hemsley, has shown impressive strategic foresight by shepherding the firm into a diverse and vertically integrated business model, with top-tier medical insurance, pharmacy benefit management, provider, and analytical assets all under one roof.”

Seeing as how complex (and practically unaffordable for most people without insurance) the US healthcare system is, having health insurance and access to an associated care network is pretty close to a necessity.

This creates a bit of a “toll road” situation for UnitedHealth, as it provides a required point of travel and collects fees for doing so.

Not only that, but once a person has health insurance and is established in an associated network, that service is very “sticky” – particularly if it’s through an employer (where a change will likely only occur if one leaves that job).

This locks clients into both the insurance and the care.

Moreover, due to prevailing demographic trends, that client pool is growing larger, older, and wealthier (on average), naturally creating more demand for quality healthcare (and the insurance to affordably access it).

If all of that weren’t already compelling enough, UnitedHealth taps into the hidden genius behind the insurance business model.

Because of the time delay between receiving money for premiums and paying out on claims, an insurance company builds up what’s known as a “float”, which is the capital that accrues over time because of this delay.

UnitedHealth ended last fiscal year with more than $75 billion in cash, cash equivalent, available-for-sale debt securities, and equity securities balances.

This is a massive pile of capital which is a low-risk profit source for UnitedHealth on top of the core business.

And while the core part of the business helps to continually generate more float capital, the capital grows all by itself through intelligent allocation.

This company has so many levers to pull and ways to win, and its vertical integration across the healthcare value chain has created an extremely defensible business model.

This is what sets it up for continued revenue, profit, and dividend growth over time.

Dividend Growth, Growth Rate, Payout Ratio and Yield

Already, UnitedHealth has increased its dividend for 15 consecutive years.

Its 10-year dividend growth rate is 19.3%, which is incredible, although the dividend growth rate has slowed and matured into a low-double-digit area (the most recent dividend raise was nearly 12%).

With the stock yielding 2.9%, LDD dividend growth is more than enough to make sense of an investment.

I usually see MSD-HSD growth when the yield is approaching 3%, so this is quite a combination.

By the way the stock’s near-3% yield easily beats the market and is 160 basis points higher than its own five-year average.

The yield is much higher than usual due to a confluence of headwinds hitting the business, which I’ll discuss soon, providing what could be a nice opportunity to lock in a lot more current income on what’s historically been one of the most solid blue-chip enterprises in America.

One is getting paid to wait – and getting paid much more than ordinary – while the business works through some challenges.

A payout ratio of 33.7%, based on EPS guidance at the midpoint for FY 2025, shows us a very healthy dividend with easy coverage.

There’s really nothing to complain about regarding the dividend.

One gets plenty of yield, growth, and safety – all in one package.

Again, it’s a nice combination.

Revenue and Earnings Growth

As nice as it may be, though, a lot of these dividend numbers are based on what’s happened in the past.

However, investors must be always fixated on the future, as today’s capital gets put on the line for tomorrow’s rewards.

As such, I’ll now build out a forward-looking growth trajectory for the business, which be highly useful 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 what we need to put an idea together of where the business could be going from here.

UnitedHealth moved its revenue from $157.1 billion in FY 2015 to $400.3 billion in FY 2024.

That’s a compound annual growth rate of 11%.

This is excellent top-line growth for a very mature business that started the preceding 10-year period with a revenue base of more than $150 billion.

To compound at 11%/year off of $150+ billion is extremely impressive, going to show just how great – and necessary –  this business model is.

That necessity is the linchpin of the investment thesis, as there’s no reality in which Americans can exist in our current healthcare system without health insurance.

Meanwhile, earnings per share grew from $6.01 to $27.66 (adjusted) over this period, which is a CAGR of 18.5%.

Very, very strong EPS growth, which is what has fueled all of that terrific dividend growth over the last decade.

Looking forward, CFRA believes that UnitedHealth will compound its EPS at an annual rate of 10% over the next three years.

This is obviously a pretty severe drop from what’s transpired over the last decade, although 10% is still a comfortable growth rate that many companies would love to have.

Still, it’s important to not dance around the challenges that UnitedHealth currently faces.

There are three primary problems to be aware of: higher medical costs, a change in leadership, and an alleged investigation by the DOJ into billing practices and possible fraud.

First, rising medical costs are weighing on the firm’s profitability and medical care ratio.

Higher costs sound (and kind of are) bad; however, insurers such as UnitedHealth actually benefit from higher costs over the long run, as higher costs feed through to higher premiums (although there is often a short-term delay between action and reaction).

We can’t miss the premium forest for the cost trees here.

Second, UnitedHealth has brought back prior CEO Stephen Hemsley (who previously led the company for more than 10 years) after former CEO Andrew Witty stepped down.

Again, this is seemingly a negative that’s actually a positive.

Witty has been unable to properly articulate the value proposition of UnitedHealth, deal with reputational fallout after a mad gunman gunned down one of the company’s leaders, and get the firm straightened out with prudent management and PR.

Hemsley, on the other hand, is a proven and highly capable manager who oversaw one of the most prolific periods of expansion for UnitedHealth, and he’s put his money where his mouth is by recently purchasing $25 million worth of company stock on the open market in order to soothe investors and create more alignment between management and common shareholders.

Regarding the DOJ investigation, there’s way too much uncertainty around just how real this situation is.

Overall, I suppose you have to ask yourself a question: Do you see any future in which US healthcare is nationalized?

If the answer to that is no, then there’s no possibility of Americans suddenly forgoing private healthcare en masse.

And being the largest provider of such insurance, with many roads leading its way, UnitedHealth almost can’t lose.

Circling back around to CFRA’s forecast, I have no problems with this number.

But we must keep in mind that this is a forecast, even though UnitedHealth’s long-term positioning appears to be as strong as ever.

I think CFRA does a good job of highlighting this juxtaposition with this passage: “While UNH’s 13%-16% long-term EPS growth appears achievable through M&A, buybacks, and cost cuts (16% three-year CAGR), we see too many near-term risks, including the DOJ Medicare billing probe, potential Medicaid cuts, and high MCRs through 2025.”

There’s the rub.

One has to determine for themselves whether they are a short-term or long-term investor.

For the latter, I see much to like.

Furthermore, even for the former, “only” 10% EPS growth would be a great number that would open up the dividend for continued LDD growth over the next few years (roughly matching that most recent dividend raise of ~12%).

If one can lock in a ~3% yield and LDD dividend growth, it’s awfully hard to do poorly over time; to the contrary, that sets one up for a mid-teens annualized total return – before assuming any kind of multiple expansion (which is extremely possible in this case, seeing as how UnitedHealth’s stock is sitting near multiyear lows on its multiples).

This situation skews heavily to the upside and implies a large margin of safety for new investors.

Financial Position

Moving over to the balance sheet, UnitedHealth has a very good financial position.

The long-term debt/equity ratio is 0.6, while the interest coverage ratio is almost 8.

While these ratios are decent, they don’t tell the whole story.

UnitedHealth’s total long-term debt load of approximately $72 billion is more than offset by the cash and investments noted earlier.

Unsurprisingly, this is a pretty conservative balance sheet.

Being an insurance company in the business of assuming risk, the balance sheet must be a fortress.

I’ve never in my life seen any insurance company act recklessly with its balance sheet, and UnitedHealth is no different.

Profitability for the firm is robust.

Return on equity has averaged 24% over the last five years, while net margin has averaged 5.6%.

UnitedHealth being able to generate high returns on capital without excessive leverage is impressive and further showcases the strength of the business model.

The margin expansion that’s played out is also worth noting, as net margin was below 4% at the beginning of the last decade.

While there are some new and temporary chinks in the armor, UnitedHealth’s core business model remains unassailable, supported by sheer necessity in a complex and extremely expensive US healthcare system.

And with economies of scale, “sticky” memberships, vertical integration, an established float, and network effects, 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.

I believe the first two of those three risks are elevated for UnitedHealth relative to the average business model, although competition is somewhat limited to only a few major players with the scale necessary to effectively compete.

Serving as a perfect example of the heightened risks around regulation and litigation, UnitedHealth is facing unwelcome DOJ scrutiny.

UnitedHealth recently experienced a cyberattack that affected its ability to manage claims, and its size and deep pockets invite this kind of behavior from bad actors.

It’s possible (albeit extremely unlikely) that that US healthcare complex undergoes some kind of fundamental change in the future (such as partial or full nationalization), and any changes would almost certainly impact UnitedHealth in a major and direct way.

The advent of GLP-1s could cause a spike in spending for UnitedHealth (due to the cost of covering these drugs), but a healthier populace would almost certainly result in lower utilization rates on the back end.

The size of UnitedHealth, while an advantage on its face, may be starting to expose the company to the law of large numbers.

Recent management turmoil adds to the uncertainty.

And while the expensive and complex US healthcare system leads right to UnitedHealth’s raison d’être, these sky-high costs are eating into the company’s profitability.

I would agree that these risks are serious and UnitedHealth may be just a skosh less strong and attractive as it used to be.

However, the valuation has come down a lot more than just a skosh, with the stock sitting near multiyear lows on multiple fronts…

Valuation

The P/E ratio of 12.5 is ludicrous for a company growing (under ordinary circumstances) at a mid-teens rate.

Just to show how ludicrous this is, it’s about half of the stock’s own five-year average P/E ratio of 24.6.

The cash flow multiple of 10.7, which is jaw-droopingly low, is also nearly half of its own five-year average of 18.7.

And the yield, as noted earlier, is substantially 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 12%, and a long-term dividend growth rate of 7.5%.

This model is slightly more conservative than the model I used the last time I analyzed and valued the business (which was about a year ago).

The change I’ve made is to drop down the near-term DGR from 14% to 12% in order to account for the current challenges faced by the firm.

This 12% mark is very close to the most recent dividend raise given out by UnitedHealth, and the forecast for 10% EPS growth over the next several years would portend for more of this ahead.

Even with the modification, a 12% dividend growth rate would still be great, especially when paired with the yield (which is way higher than normal).

And I’m also making no changes to the long-term growth trajectory, as I (like CFRA) feel that UnitedHealth’s longer-term story remains fully intact.

It’s simply hard to imagine UnitedHealth, with all of its necessity and resources, not being able to grow at a HSD rate over the long run.

The DDM analysis gives me a fair value of $525.39.

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 stock, which has historically been one of the US’s bluest-chip names, looks extremely cheap  to me after its recent 50% 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 UNH as a 4-star stock, with a fair value estimate of $473.00.

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 UNH as a 2-star “SELL”, with a 12-month target price of $216.00.

I came out on the high end, although only CFRA is the real outlier here. Averaging the three numbers out gives us a final valuation of $404.80, which would indicate the stock is possibly 26% undervalued.

Bottom line: UnitedHealth Group Inc. (UNH) is a high-quality, blue-chip company that offers its clients something completely necessary in order to affordably navigate an extremely complex and expensive US healthcare system. In exchange for offering clients an “on-ramp”, it collects a healthy “toll”, and it’s parlayed those tolls into unmatched scale and float advantages. New chinks in the armor are modestly concerning, but the core business model remains unassailable. With a market-beating yield, double-digit dividend growth, a low payout ratio, 15 consecutive years of dividend increases, and the potential that shares are 26% undervalued, long-term dividend growth investors who like to be greedy when others are fearful have a clear shot on goal right now.

-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 UNH’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 80. 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, UNH’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.

Disclosure: I’m long UNH.