When I was really young, I thought having money was all about being able to buy stuff.
A fancy car, a nice house, a big boat, etc.
However, now that I’m an adult with a brain, it’s clear to me how wrong that is.
It’s not about the things you can buy.
The value of money can be found in the non-things you can buy.
Concepts like time, optionality, and freedom are way more important than physical possessions.
And this is why I’m so glad I started employing the dividend growth investing strategy more than 15 years ago.
This is a long-term investment strategy almost purpose-built for achieving financial freedom, due to the way in which it funnels investors right into great businesses paying out steadily rising cash dividends.
These steadily rising cash dividends can be an incredible bedrock for financial freedom by replacing a paycheck and allowing one to live off of totally passive income instead.
You can find hundreds of businesses out there paying steadily rising cash dividends by pulling up the Dividend Champions, Contenders, and Challengers list – an invaluable source of rich data on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
By following this strategy, I’ve been able to build the FIRE Fund.
That’s my real-money portfolio which generates enough five-figure passive dividend income for me to live off.
In turn, this passive dividend income allowed me to retire in my early 30s.
Of course, the strategy isn’t about picking random stocks off of a list.
It’s about making thoughtful, informed, well-researched investment choices that also factor in valuation at the time of making any investment.
And 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.
Slowly but surely building a portfolio full of undervalued high-quality dividend growth stocks is one of the best ways to unlock financial freedom over time, which is one of the highest uses for money itself.
The whole topic of valuation might seem complicated at first, but it’s really not.
If it seems like a lot to you, make sure to give Lesson 11: Valuation a read.
Written by fellow contributor Dave Van Knapp, it explains valuation using very simple terminology and even provides an easy-to-use template you can apply 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…
Steris PLC (STE)
Steris PLC (STE) is an American, Ireland-domiciled medical equipment company.
Founded in 1985, the company is now a $21 billion (by market cap) med tech player employing approximately 18,000 people.
The company reports results across three segments: Healthcare, 71%, of FY 2026 revenue; Applied Sterilization Technologies, 19%; and Life Sciences, 10%.
Steris has a very appropriate and telling corporate name.
The company provides infection prevention products and sterilization services to medical clientele (such as hospitals, outpatient surgery centers, and pharmaceutical companies).
Simply put, Steris specializes in sterilization.
It’s a great business model for three reasons.
First, it’s impossible to imagine a future in which medical products will not need sterilization.
It’s critical and necessary.
Moreover, an aging population results in a secular uplift to demand for medical procedures.
As such, there’s a lot of long-term visibility, resiliency, and durability.
Second, despite that criticality and necessity, what Steris offers is a low-cost portion of any medical process.
This reinforces the durability.
Third, sterilization is a process that must be repeated over and over again, leading to recurring revenue for the company (via consumables and services).
Steris utilizes the razor-and-blade model by selling a range of capital equipment (such as large sterilizers) which often require consumables (such as detergents).
Unsurprisingly, this combination has allowed Steris to develop steady, reliable growth across its revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Already, Steris has increased its dividend for 21 consecutive years.
The 10-year dividend growth rate of 9.6% is strong, but more recent dividend raises have actually been over 10%.
Steris has been a terrific, double-digit dividend grower.
However, the trade-off here is the stock’s lowish yield of 1.2%.
This is an unsurprising and very common trade-off.
In fact, the trade-off as it exists now isn’t as bad as it usually is, as the stock’s current yield is actually 30 basis points higher than its own five-year average.
This stock usually yields less than 1%, so this is a relatively advantageous time to be looking at it (which is why I’m featuring it now).
With a payout ratio of only 31.8%, the dividend appears to be very safe and has plenty of room to aggressively head higher over the coming years.
This is an excellent dividend profile, although it’ll likely be more suitable for younger dividend growth investors who understand the power of compounding and have the time to let it play out.
Revenue and Earnings Growth
As excellent as it may be, though, much of this is based on past data.
However, investors must always be focused on the future, as the capital of today is risked for the rewards of tomorrow.
This is why I’ll now build out a forward-looking growth trajectory for the business, which will be of great use 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.
And 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 the ability to estimate where the business could be going from here.
Steris grew its revenue from $2.6 billion in FY 2017 to $5.9 billion in FY 2026.
That’s a compound annual growth rate of 9.5%.
Impressive top-line growth out of a fairly mature healthcare company.
Meanwhile, earnings per share rose from $1.28 to $7.93, which is a CAGR of 22.5%.
This is blistering bottom-line growth.
Now, the starting point was quite a bit lower than it should have been due to some impacts.
However, on the flip side, adjusted EPS for FY 2026 was $10.17.
If we account for the adjusted figures, the 10-year EPS CAGR is closer to 12%.
I think that’s a more accurate depiction of the company’s true growth.
Still great.
Just not quite so spectacular.
Looking forward, CFRA has a forecast that Steris will compound its EPS at an annual rate of 8% over the next three years.
This would represent a fairly material slowdown relative to what Steris did over the last decade (both in GAAP and adjusted terms).
CFRA likes that Steris is an end-to-end infection prevention provider with recurring revenue and demographic support (i.e., aging).
Furthermore, Steris is providing low-cost, “sticky”, mission-critical products.
That’s a heck of a setup.
Reinforcing that setup is what CFRA sees as a structural change following the pandemic, whereby there is now more awareness regarding general healthcare cleanliness.
Steris also has room for M&A opportunities.
Given all of this, I think the 8% number is too conservative.
For its part, Steris itself is guiding for 9% to 11% YOY adjusted EPS growth for the upcoming year, which is closer to the long-term trend.
Steris has been generating low-double-digit EPS and dividend growth for years, and I just don’t see anything to justify assuming a material deviation from the norm.
In my view, it’s more of the status quo.
And the status quo is great.
Layering low-double-digit dividend growth on top of the starting yield gets one to a low-teens type of annualized total return, which lines right up with the stock’s 10-year all-in CAGR of 13% (including reinvested dividends).
Financial Position
Moving over to the balance sheet, Steris has a great financial position.
Its long-term debt/equity ratio is 0.3, while the interest coverage ratio is over 18.
The company also has investment-grade credit ratings: Baa2, Mood’s; BBB, S&P.
To be honest, I’m surprised Steris doesn’t have even higher credit ratings.
I have no qualms whatsoever about this balance sheet.
Profitability is decent, but I see a lot of room for improvement in this department.
Return on equity has averaged 6.7% over the last five years, while net margin has averaged 8.5%.
ROIC frequently fails to hit double-digit territory.
The returns on capital being generated by the business are disappointing, but I’d also say this is really the only true weak spot of the whole business.
Overall, besides the low returns on capital, Steris is a pretty terrific business.
And with economies of scale, “sticky” products, switching costs, established relationships, entrenched capital equipment, barriers to entry, R&D, and IP, 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.
Regulation is an interesting issue that can be just as much of a benefit as a risk (due to the regulatory barriers to entry).
That said, competitive pressures are endless, and litigation is a constant threat.
Any major changes to the US healthcare complex would almost certainly affect Steris.
Steris has exposure to geopolitics and exchange rates.
Technology (especially now with AI) is changing all industries, including healthcare, and novel technologies in the future may allow new entrants to come in and more effectively compete in this space.
Steris is active in M&A, which introduces execution risks, valuation risks, and balance sheet risks.
Weighed against the quality and attractiveness of the business as a whole, I find these risks to be quite acceptable.
Also quite acceptable is the valuation, which looks better than it has in years after a recent 20%+ drawdown…
Valuation
The P/E ratio is now down to 26.6.
That’s far lower than its five-year average of 46.8.
And this is using GAAP results.
Using adjusted EPS, the P/E ratio drops further to 20.7.
If we move past the GAAP messiness, the cash flow multiple of 15.8, which is highly reasonable for a business like this, is also noticeably below its own five-year average of 21.2.
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 12%, and a long-term dividend growth rate of 8%.
What I’m doing here is extrapolating out the recent trend of accelerating dividend growth, where it’s been moving from a 9%+ base to a 10%+ rate.
Moreover, this near-term 12% number lines up perfectly with the 10-year adjusted EPS CAGR.
With the payout ratio being where it’s at and with Steris itself guiding for more double-digit (at the midpoint) adjusted EPS growth, I don’t see why the business can’t sustain a low-double-digit dividend growth rate.
Perhaps 12% isn’t quite reached over the next decade, but the double-digit growth may also extend out well beyond the next decade.
I think the model is balanced on both sides of that.
The DDM analysis gives me a fair value of $190.81.
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.
The recent drawdown may have created an interesting entry point on a name that I’ve always found to be simply too expensive.
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 STE as a 4-star stock, with a fair value estimate of $244.00.
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 STE as a 4-star “BUY”, with a 12-month target price of $275.00.
Maybe I was too cautious with my model? Averaging the three numbers out gives us a final valuation of $236.60, which would indicate the stock is possibly 11% undervalued.
Bottom line: Steris PLC (STE) is a high-quality business employing the razor-and-blade model to great effect. It has numerous tailwinds blowing its way, boding well for the firm’s long-term trajectory. With a market-beating yield, high-single-digit dividend growth, a low payout ratio, more than 20 consecutive years of dividend increases, and the potential that shares are 11% undervalued, this looks like one of the best moments in years for long-term dividend growth investors to buy shares in this sterilization leader.
-Jason Fieber
Note from D&I: How safe is STE‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 88. 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, STE’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 STE.
