Having autonomy in one’s life is priceless.
It comes down to the simple ability to do as one pleases.
In this world, most of us have to do a lot of things we don’t really want to in pursuit of the financial resources necessary to put food on the table and a roof over our heads.
Autonomy breaks the mold and allows one to make better, more individualized choices.
Unlocking autonomy through the independent wealth and passive income gained via investing isn’t just nice to have but a must.
And when it comes to investing with this end in mind, I think dividend growth investing is the very best strategy one could implement.
This strategy almost automatically funnels an investor right into the great businesses of the world – businesses so great that profits are increasing like clockwork, giving way to rising cash dividend payments to shareholders.
You can find hundreds of examples of what I mean by taking a look at the Dividend Champions, Contenders, and Challengers list, which has compiled data on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
These rising cash dividend payments can be an excellent foundation for the passive income you need to gain that aforementioned autonomy.
I’ve gained this autonomy myself, using dividend growth investing as the pathway there.
This pathway led me to building the FIRE Fund.
That’s my real-money portfolio, and it generates enough five-figure passive dividend income for me to live off of.
This 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.
My Early Retirement Blueprint shares how I put myself in that position (and how you can put yourself in the same position).
Now, applying the dividend growth investing strategy properly and intelligently involves paying a lot of attention to valuation at the time of making any investment.
That’s because price only tells you what you pay, but 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.
Properly applying the dividend growth investing strategy and building out a portfolio of undervalued high-quality dividend growth stocks can unlock the autonomy you need to live the life of your choosing.
Of course, spotting undervaluation first requires one to understand how valuation works.
Well, that’s where Lesson 11: Valuation comes in.
Written by fellow contributor Dave Van Knapp as part of a series of “lessons” designed to teach the dividend growth investing strategy, it spells out valuation in simple-to-understand terms and even provides a guide you can use 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…
Eversource Energy (ES)
Eversource Energy (ES) is an American utility holding company.
Founded in 1927, Eversource Energy is now a $24 billion (by market cap) major utility player that employs more than 10,000 people.
Eversource Energy operates regulated electric, gas, and water distribution utilities in the states of Connecticut, Massachusetts, and New Hampshire.
The Electric Distribution segment accounted for 60% of FY 2024 revenue (prior to eliminations); Natural Gas Distribution, 14%; Electric Transmission, 14%; and Water Distribution, 2%. Other accounted for the remainder.
The company serves approximately 4.4 million customers, with the vast majority of them (~3.3 million) being electric utility customers.
A regulated utility can be a solid long-term investment.
This is a business model providing its captive customers with something they cannot live without in a modern-day society.
People say they can’t live without smartphones or access to the Internet.
Trust me, as someone who lived the first half of my life without either, you can most certainly live just fine without these things.
Instead, try living without electricity for a few days.
While you could technically survive, it would be incredibly difficult to live much of a life.
There’s sheer necessity at play here.
Furthermore, power utilities across the US run local monopolies, as there is almost always just one provider for any single geographic area.
Combining this basic need with a localized monopoly creates a beholden customer base which will automatically seek these services and reliably pay for them (out of fear of losing services).
It’s as close to “guaranteed” revenue as it gets.
However, because of how easy it would be to take advantage of this, and in order to provide some protection to regular consumers, utilities are heavily regulated by government bodies.
The regulatory framework creates both a floor underneath the business model and a ceiling on the possible profits.
In exchange for investing in infrastructure and providing necessary services, utilities are allowed a reasonable rate of return on its investments.
This “floor” underneath the business model supports recurring revenue.
Putting a fine point on this, Eversource Energy’s current plan calls for investing slightly more than $23 billion between 2024 and 2028 in order to upgrade core infrastructure, ensure dependable service to customers, and drive returns on these investments under its regulatory framework.
In particular, because its region is expecting electric demand to more than double by 2050, management is aggressively pursuing an electrification strategy.
On the other hand, the rates that can be charged are capped by regulators.
This “ceiling” on profit limits just how much money a utility can make, which feeds through to limited returns for investors.
As such, the attractiveness of a utility depends on one’s viewpoint, which will shaped by how much one personally values highly visible and recurring revenue (rather than massive upside potential).
But running a local monopoly with regulation-backed profit supported by huge investments and an electrification strategy will almost certainly promote higher revenue and profit over the decades to come, which should then lead to bigger dividends to shareholders.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, Eversource Energy has already increased its dividend for 27 consecutive years.
That qualifies the company for its vaunted status as a Dividend Aristocrat.
It’s not a household name, and I think a lot of investors might not even know about this being a Dividend Aristocrat, but its dividend growth track record is mightily impressive.
To that point, its 10-year dividend growth rate is 6.2%.
The highest growth rate out there?
Of course not.
But it’s actually one of the stronger ones I’ve seen among power utilities.
And it gets better.
The yield is also one of the stronger ones I’ve seen out there.
This stock yields 4.6%.
Even in the land of utilities, where higher yields are common, this yield stands out (in a good way).
This yield is also 130 basis points higher than its own five-year average.
What I see is an above-average yield and above-average dividend growth rate.
It’s a heck of a combination.
And with a payout ratio of 63.4%, based on midpoint guidance for FY 2025 EPS, the dividend remains as secure as ever.
For income-oriented investors, this is one of the most alluring yields in its space.
Revenue and Earnings Growth
As alluring as it may be, though, a lot of the dividend metrics cited above are looking backward.
However, investors must have a forward-looking mindset, 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 be of aid 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.
Blending the proven past with a future forecast in this way should give us a foundation for putting together an idea of where the business might be going from here.
Eversource Energy advanced its revenue from $8 billion in FY 2015 to $11.9 billion in FY 2024.
That’s a compound annual growth rate of 4.5%.
Not bad.
Somewhat typical growth for a power utility.
Meanwhile, earnings per share went from $2.76 to $4.57 (adjusted) over this period, which is a CAGR of 5.8%.
Pretty standard stuff for a power utility.
I see neither anything horrible nor anything exceptional.
One invests in a business like this for its steady, reliable, growing dividend income backed by necessary services with ~100% recurring revenue, not because one expects a lot of growth.
Now, I should point out that I used adjusted EPS for FY 2024.
That’s because Eversource Energy’s GAAP EPS has recently been affected by impairments.
Management had taken what was “easy money” from its core regulated utility business and made things more difficult by by pursuing complex offshore wind energy projects which were outside of its core competency.
These ill-advised investments turned out poorly.
The company completed the exit of its offshore wind business in Q3 2024, capping off a series of impairments, and Eversource Energy is now a pure-play regulated utility (and the largest of its kind on the New England region).
This is an important milestone, as the misstep regarding offshore wind investments was an overhang on the business and stock. that had really limited investor/market enthusiasm around this idea.
Limited enthusiasm shown by the market has led to the stock being mercilessly punished over the last several years (the stock is still down more than 30% from 2022 highs).
With the offshore wind exposure is now gone, freeing up management to focus solely on its capital investment plan to fuel growth, the business and stock should perform better from here.
We have a combination of removed distractions on the business and low expectations on the stock.
It’s a nice setup that makes the idea more appealing than it’s been in years.
This might be of little consolation to those who have rode the wave all the way through, but new investors starting in now from scratch have much to be excited about.
Looking forward, CFRA is modeling in a 5% CAGR for Eversource Energy’s EPS over the next three years.
I think that’s a pretty fair assumption to make.
Not much of an explanation to lay out here, either, as this is not far off from what the business has done over the last decade (albeit only when using adjusted EPS for FY 2024).
This kind of growth is right down the middle of the plate for a regulated utility.
Most grow at a mid-single-digit rate, and I don’t see why Eversource Energy will be all that different (for better or worse).
In fact, simply doing what other utilities do would go a long way toward repairing the company’s reputation and its stock’s performance.
And this kind of bottom-line growth would fuel similar dividend growth.
Helping to allay investors’ concerns and confusion further is the company’s planned exit from its smaller water business.
Eversource Energy reported earlier this year that it had reached an agreement to sell its water distribution subsidiary Aquarion for nearly $2.5 billion (which it expects to close later this year), and it plans to use the proceeds to reduce debt.
With the offshore wind and water businesses gone, this will remake Eversource Energy into a pure-play regulated power utility company.
This makes it much easier to understand, appreciate, and value by the market.
It will take time for market confidence to be fully restored, and that delay could be where the opportunity is.
If we get ~5% bottom-line and dividend growth out of this, and one is starting off with a 4.5%+ yield, that gets one to a ~10% annualized total return even with no major changes in the valuation.
Again, though, when confidence is fully restored, this stock should reclaim its former glory – and that would involve a big move upward in pricing and valuation.
That’s free optionality on what is already a nice yield, decent growth, and a very acceptable return profile.
For value-conscious, income-oriented, safety-seeking investors, it’s tough to go wrong with that kind of situation on a Dividend Aristocrat.
Financial Position
Moving over to the balance sheet, Eversource Energy has a somewhat poor financial position.
The long-term debt/equity ratio is 1.7, while the interest coverage ratio is just over 2.
Even by the low standards of a power utility, this is kind of an ugly balance sheet.
Capital allocation in recent years has been poor, and the long-term debt load has more than tripled over the last decade, but there’s light at the end of the tunnel: The capital from the Aquarion deal will reduce leverage and some of the stress on the balance sheet.
Also, it should be pointed out that all power utilities, by design, have balance sheets which are heavily leveraged, due to how growth plans are usually funded through equity and debt (with ROI backing from regulators).
There are companies that are “too big to fail”, but power utilities are “too critical to fail”.
Giving additional confidence is the investment-grade credit ratings for the parent company: BBB+, S&P; Baa2, Moody’s; BBB, Fitch.
Profitability is usually decent and fairly standard for a power utility, although it’s been temporarily depressed by poor capital allocation choices over the last few years.
Return on equity has averaged 5.9% over the last five years, while net margin has averaged 8.1%.
In ordinary times, Eversource Energy puts up ~9% ROE.
Again, not outstanding, but it’s a respectable number for a power utility dealing with a tough regulatory environment.
Overall, what I see is a good core power utility business in the process of being restored to its full potential.
And with economies of scale, established infrastructure, and monopolistic control over its service territories, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
While competition is effectively eliminated through local service territory monopolies, regulation is magnified for this business model and purposely limits growth through a government-enforced regulatory framework.
Connecticut, which represents ~25% of the company’s earnings, has been a particularly challenging regulatory district.
The offshore wind debacle introduces many questions around execution and management’s ability to make sound capital allocation decisions.
The company’s balance sheet is in somewhat poor condition, limiting how fast and big the company can go on growth/infrastructure projects.
Its territories have a “progressive” stance, which could see an increasing shift away from natural gas (impacting ~15% of revenue), and the further push into electrification heads this off, but the cold climates will likely require the usage of natural gas for heating for the indefinite future.
Natural disasters, especially fires, are always a possible hazard for utilities.
Other than the offshore wind mistakes, the risks are largely customary for a power utility.
Yet, with the stock in the doldrums and still more than 30% down from recent highs, the valuation is anything but customary…
Valuation
The forward P/E ratio, based on midpoint guidance for this year’s EPS, is only 13.7.
While I don’t see why this kind of business should command high multiples, this kind of earnings multiple is well below the industry average.
It’s also well below the stock’s own five-year average P/E ratio of 22.1 (although this is skewed by hits to GAAP earnings).
If we want to move past the impairments, even the revenue multiple of 1.9 is quite a bit lower than its own five-year average of 2.3.
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 5.5%.
The growth rate I’m modeling in is lower than the demonstrated dividend growth over the last decade.
What I’m doing here is, I’m roughly splitting the difference between the 10-year EPS CAGR and the near-term forecast for EPS growth (which is what will fuel dividend growth).
The most recent dividend increase came in at just over 5%, and I think that’s right about what shareholders should expect over the coming years.
I do think there’s room for an upside surprise here, but I’d rather err on the side of caution.
The DDM analysis gives me a fair value of $70.57.
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 see a nice bargain in a market that has seen a lot of stocks run very high.
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 ES as a 4-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 ES as a 3-star “HOLD”, with a 12-month target price of $70.00.
We have a tight consensus. Averaging the three numbers out gives us a final valuation of $71.19, which would indicate the stock is possibly 9% undervalued.
Bottom line: Eversource Energy (ES) has a good core utility business which is seeing renewed focus, better capital allocation decisions, and a restoration to its former glory. Its captive customers can’t live without what it provides, creating ~100% recurring revenue. And it runs localized monopolies across its service territories. With a market-smashing yield, mid-single-digit dividend growth, a reasonable payout ratio, more than 25 consecutive years of dividend increases, and the potential that shares are 9% undervalued, long-term dividend growth investors should take a good look at this Dividend Aristocrat while it’s still being marked down.
-Jason Fieber
Note from D&I: How safe is ES’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, ES’s dividend appears Safe with an 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 ES.
