Is there any other way to live than the way that best suits you?

As long as you’re not hurting anyone, you should be free to live life in whatever way you wish.

However, this is a lot easier said than done.

Primarily, a lot of the difficulty comes down to finances.

If one isn’t financially free, a lot of available time gets taken up by working for money.

And this is why seeking financial independence as soon as possible in life is crucial.

Once you can cover the bills without working, that sets you up to realize the life you truly want to live.

While there are a lot of paths one can take in this pursuit, I think dividend growth investing is the best of all.

This is a long-term investment strategy whereby one buys and holds shares in world-class businesses rewarding shareholders with steadily rising dividends.

These steadily rising dividends emanate from steadily rising profits, and steadily rising profits tend to only be possible when a business is of a high enough quality.

You can see what I mean by perusing 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.

You’ll see one great business after another here, and great businesses often make for great long-term investments.

I’ve been using the dividend growth investing strategy for more than 15 years now, allowing it to guide me as I’ve gone about building the FIRE Fund.

That’s my real-money portfolio which generates enough five-figure passive dividend income for me to live off of.

I’ve actually been able to live off this since I retired in my early 30s.

How is such an early retirement possible?

Well, my Early Retirement Blueprint shares the details.

Now, while great businesses can make for great long-term investments, valuation at the time of making any investment is of critical importance.

Price only represents what you pay, but value represents 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.

Achieving financial independence sets one up to live life on their terms, and the best way to achieve financial independence might be by routinely buying undervalued high-quality dividend growth stocks.

Of course, being able to spot possible undervaluation first requires an understanding of what valuation is all about.

That’s where Lesson 11: Valuation comes in.

Put together by fellow contributor Dave Van Knapp, it spells out valuation using easy-to-understand terminology and even provides a template 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…

Moody’s Corp. (MCO)

Moody’s Corp. (MCO) is a US-based financial services company.

Founded in 1909, Moody’s is now a $79 billion (by market cap) ratings giant employing 16,000 people.

The company reports results across two segments: Moody’s Investors Service, 53% of FY 2025 revenue; and Moody’s Analytics, 47%.

Just over half of revenue comes from the US, with the remainder coming from a variety of international markets.

It’s under the MIS segment that Moody’s does its bread and butter by providing corporate credit ratings globally.

Essentially, this is a risk assessment firm.

Moody’s analyzes businesses from around the world and provides credit ratings and assessment services on a wide range of debt obligations.

The originators pay Moody’s to rate debt instruments so that they can be publicly issued to liquid markets where capital can be widely accessed.

These instruments basically must be rated by at least one agency, creating a captive customer base and highly recurring revenue.

Moody’s has something close to guaranteed business.

Moreover, Moody’s operates within the favorable confines of an oligopoly, as there are only three major corporate credit rating agencies worldwide (among which Moody’s ranks second, with an estimated 25% market share).

Through more than a century of building trust and market share upon proprietary data and expertise, Moody’s sits upon an almost unbreakable, irreplaceable perch in global financial markets.

It’s a vital, necessary cog in a machine – a prominent part of the value chain.

And this is why it reliably generates high levels of growth across its revenue, profit, and dividend.

Dividend Growth, Growth Rate, Payout Ratio and Yield

To date, Moody’s has increased its dividend for 17 consecutive years.

Its 10-year dividend growth rate is 10.7%, which is solid, but the most impressive part about it might be how consistent it’s been: Moody’s hands out a 10% or better dividend raise pretty much every year.

Yet, with the payout ratio sitting at just 29.5%, the dividend growth machine is in fine shape and poised to continue cranking out the big dividend raises.

There is a trade-off for accessing such consistent double-digit dividend growth, however.

And that’s the stock’s lowish yield of just 0.9%.

Now, this stock has yielded something along these lines for about as long as I’ve been investing (dating back more than 15 years now).

To that point, this yield is actually 10 basis points higher than its own five-year average, so it’s not as low as it usually is.

Despite that, because the business is so good and reliably growing so briskly, the stock has been an absolute blockbuster investment for decades.

For those who appreciate total return and aren’t in dire need of immediate income, Moody’s is a high-quality compounder for the ages.

Revenue and Earnings Growth

As much as it may be, though, a lot of the dividend profile here is sketched up using data from the past.

However, investors must always be firmly fixed upon the future, as today’s capital is risked for tomorrow’s rewards.

As such, I’ll now build out a forward-looking growth trajectory for the business, which will come in handy during the valuation process.

I’ll first show you what the business has done over the last ten years 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 position us to estimate with reasonable confidence where the business may be going from here.

Moody’s moved its revenue from $3.6 billion in FY 2016 to $7.7 billion in FY 2025.

That’s a compound annual growth rate of 8.8%.

I’m usually looking for a mid-single-digit type of top-line growth rate from a mature company like this, but Moody’s is well above that.

Meanwhile, earnings per share grew from $1.36 to $13.67 over this period, which is a CAGR of 28.5%.

As incredible as this is, it’s largely an artifact of a weak starting year, as FY 2016 included legal overhang costs dating back to the GFC.

If we advance things one year, Moody’s sports a 13% CAGR in its EPS over the last nine years, helped along by steady buybacks and margin expansion.

That 13% mark is a much more accurate representation of the true earnings growth profile.

Looking forward, CFRA forecasts that Moody’s will compound its EPS at an annual rate of 15% over the next three years.

This builds in a modest acceleration off of the nine-year base I just laid out.

CFRA justifies this based on an improving M&A landscape, AI-driven financing needs (which increases demand for debt and ratings), and favorable IPO conditions (which should be met with increased issuances and ratings).

All of that adds up to more demand for what Moody’s provides.

And that comes on top of what CFRA notes is a global oligopoly with barriers to entry that are about as high as they get.

It’s structurally already a very attractive business model, and the mounting market tailwinds make it that much more attractive.

This bodes extremely well for the dividend.

While the 10%+ dividend growth rate is strong at first glance, it’s clear that Moody’s has actually been sandbagging.

The business is growing quite a bit faster than the dividend.

That’s why the payout ratio is currently so low, despite all of those double-digit dividend raises.

With an acceleration in bottom-line growth expected, and with the payout ratio now compressed, I’d be very surprised if dividend growth doesn’t pick up meaningfully off of that 10% level.

Adding that to the starting yield easily positions shareholders for a mid-teens type of annualized total return over the coming years, which is obviously very appealing.

By the way, Warren Buffett spotted this appeal nearly 30 years ago and put some serious capital to work behind an investment in Moody’s (that position is now worth over $11 billion).

Being invested alongside the Oracle of Omaha himself only adds to the allure.

Financial Position

Moving over to the balance sheet, Moody’s has a good financial position.

Its long-term debt/equity ratio is 1.7, while the interest coverage ratio is over 12.

I wouldn’t mind seeing better metrics here, especially considering the fact that Moody’s is in the very business of risk assessment.

However, it’s important to note that the balance sheet has improved quite a bit over the last five years, with cash up and long-term debt down.

Moreover, the A- credit rating from S&P, which is well into investment-grade territory, provides further reassurance regarding Moody’s.

Profitability is outstanding.

Return on equity has averaged 67% over the last five years, while net margin has averaged 29.8%.

ROIC is routinely well over 20%.

These are sky-high returns on capital and margins – hallmarks of a very high-quality business.

Overall, Moody’s is a wonderful business, which explains why Warren Buffett himself has been a huge fan and investor for decades.

And with economies of scale, entrenchment within a global oligopoly, established relationships based on trust, network effects, brand power, more than a century of proven results, and barriers to entry, 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.

Competition is very limited to only two other major global players, largely insulating Moody’s from this key risk.

Also, regulation might be just as much of an opportunity as a risk, as regulation makes it difficult for new competitors to enter the market and achieve scale.

The company is exposed to broader macroeconomics, as bond issuances can drop when there’s less economic health and activity.

On this same point, Moody’s has exposure to interest rates, as rates can affect demand for fixed-income instruments.

Also, Moody’s is exposed to general market conditions (such as M&A activity, “animal spirits”, etc.).

AI has unknown implications for Moody’s, and it’s possible that AI could significantly disrupt this business model at some point in the future.

Being a global company, Moody’s is exposed to geopolitics and exchange rates.

There’s also a limitation of the TAM, which introduces questions around the law of large numbers, as I see few chances to expand into new verticals (i.e., Moody’s is “locked in”).

While I see some risks here, Moody’s has deftly navigated almost all of these for more than a century now – and grown briskly along the way.

The sudden change I see is in the valuation, which has become much more attractive after a recent correction…

Valuation

The stock is now trading hands for a P/E ratio of 32.3.

Optically, in absolute terms, that’s not cheap at all.

However, this is a stock that has almost always commanded a very healthy (and deserved, some might say) premium.

Even Buffett has been willing to accept the high multiples.

Now, that’s in absolute terms.

But in relative terms, this is actually quite a bit lower than its own five-year average P/E ratio of 37.5.

The cash flow multiple of 25.1 is also well below its own five-year average of 29.9, indicating quite a bit of the premium being already boiled off.

And the yield, as noted earlier, is 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 15%, and a long-term dividend growth rate of 8%.

I’m baking in an acceleration in dividend growth here, supported by the fact that the business has been growing quite a bit faster than the dividend over the last decade.

This has resulted in a compression of the payout ratio.

Furthermore, with the near-term forecast for EPS growth at 15% per year, this would easily defend like dividend growth (even without any payout ratio expansion).

Whether or not Moody’s decides to continue sandbagging it on the dividend raises is up for debate, but the financial ability to grow the dividend at a faster rate is without question.

On the flip side, if Moody’s is unwilling to up the pace on the dividend raises, it does become difficult to justify the valuation.

The DDM analysis gives me a fair value of $400.05.

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, this stock has gone from way too expensive to at least something in the realm of reasonableness.

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 MCO as a 4-star stock, with a fair value estimate of $500.00.

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 MCO as a 4-star “BUY”, with a 12-month target price of $610.00.

Perhaps I’m being too cautious here. Averaging the the three numbers out gives us a final valuation of $503.35, which would indicate the stock is possibly 10% undervalued.

Bottom line: Moody’s Corp. (MCO) is a world-class business that has been given a huge endorsement by no other than Warren Buffett. Operating within the favorable confines of a global oligopoly and generating sky-high returns on capital, few businesses can match this level of pedigree. With a market-like yield, double-digit dividend growth, a low payout ratio, nearly 20 consecutive years of dividend increases, and the potential that shares are 10% undervalued, this looks like a rare opportunity to snap up this high-quality compounder.

-Jason Fieber

Note from D&I: How safe is MCO‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 83. 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, MCO’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 MCO.