There comes a point in life in which you start to realize that you may have already lived more years than you’ve got ahead.
You’re now on the so-called “back nine” of life.
This realization starts to occur in one’s 40s.
And it’s definitely in full swing by the time the 50s roll around.
One of the biggest epiphanies to come out of all of this for most people is how much more valuable time is than money.
That’s exactly why financial freedom is so important.
In order to have the time to do the things we want to do, we must first make sure the bills get paid and we can financially afford those things.
This is why I started chasing financial freedom in my late 20s, using dividend growth investing to get there.
Dividend growth investing is a long-term investment strategy whereby one buys and holds shares in high-quality businesses rewarding shareholders with reliable, rising cash dividends.
Once there’s enough dividend income in place to cover all bills, you’re home free.
You can find hundreds of businesses qualifying for this strategy over at the Dividend Champions, Contenders, and Challengers list.
This list has curated information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
By employing the dividend growth investing strategy for 15+ years, I’ve been able to build the FIRE Fund.
That’s my real-money portfolio generating enough five-figure passive dividend income for me to live off of.
As powerful as this strategy can be, though, there’s more to it than investing in the right businesses.
Investing at the right valuations is also critical.
See, 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.
Steadily acquiring undervalued high-quality dividend growth stocks can be a fabulous way to build toward financial freedom and achieve the ability to value time over money.
Now, knowing whether or not something might be undervalued first requires one to understand the ins and outs of the whole concept of valuation.
Well, that’s where Lesson 11: Valuation comes in.
Put together by fellow contributor Dave Van Knapp, it deftly explains what valuation is all about and even provides simple-to-use valuation tools you can easily 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…
Motorola Solutions, Inc. (MSI) is an American technology company.
Founded in 1928, Motorola is now a $69 billion (by market cap) tech leader employing more than 20,000 people.
Motorola provides a range of safety and security products and services, such as surveillance equipment and command and control systems, largely used by enterprises and public safety agencies.
The company’s revenue composition is roughly two-thirds hardware and one-third software/services.
This is a very effective setup.
Motorola sells unique, mission-critical components (such as vehicle-mounted radios) upfront, and it then provides proprietary software on an ongoing basis which is sometimes required in order for the hardware to work.
The company also provides ongoing technical, maintenance, and repair support for its products.
Motorola’s offerings have never been more in need or demand than now, largely due to the way in which society is evolving (or, perhaps, devolving).
Any world in which you could leave your door unlocked overnight is long gone.
Crime and danger seemingly lurk everywhere.
Moreover, distrust of institutions appears to be on the rise, making certain equipment (such as body-worn cameras for police officers) a practical requirement (and sometimes a legal mandate).
In my view, any company that provide products to make a world populated by human beings more safe and secure has an endless runway in front of it.
This is why Motorola is consistently prolific when it comes to generating revenue, profit, and dividend growth.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, Motorola has increased its dividend for 16 consecutive years.
Its 10-year dividend growth rate of 12.4% shows what a prolific dividend grower it’s been, and even more recent dividend raises have still been well over 10%.
The trade-off one makes in order to access this double-digit dividend growth is the stock’s lowish starting yield of 1.1%.
But those who appreciate and understand the long-term power of compounding will look at the 20%+ 10-year CAGR on the stock (including reinvested dividends) and salivate.
With the payout ratio at 39%, the dividend clearly has plenty of room to head higher over the coming years.
That means this compounder is positioned to continue compounding, which is a wonderful setup for those with the time necessary to play that out.
Revenue and Earnings Growth
As wonderful as it may be, though, that view is largely predicated on prior events.
However, investors must always be anticipating future events to come, as today’s capital is ultimately risked for tomorrow’s rewards.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will come in handy when the time comes to estimate fair value.
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 imbue us with the ability to roughly gauge where the business might be going from here.
Motorola raised its revenue from $6 billion in FY 2016 to $11.7 billion in FY 2025.
That’s a compound annual growth rate of 7.7%.
Very solid.
Meanwhile, earnings per share advanced from $3.24 to $12.75 over this period, which is a CAGR of 16.4%.
Outstanding bottom-line growth, aided by significant margin expansion.
Looking forward, CFRA is anticipating that Motorola will deliver a 10% CAGR in its EPS over the next three years.
This would represent a material step down in for Motorola, but it’s not totally out of line with more recent adjusted numbers out the business.
FY 2025 saw an 11% YOY jump in adjusted EPS.
For its part, Motorola is guiding for $16.93 in midpoint adjusted EPS for FY 2026, which would be a 10% YOY increase.
CFRA’s forecast seems dialed in.
Notably, Motorola has a $15.7 billion backlog, which is more than annual revenue, providing excellent near-term visibility.
And that margin expansion I quickly touched on earlier comes down to a shift toward “sticky” peripheral software and services added on top of core hardware products.
That only adds to the high switching costs already in place, as government agencies are not going to just switch car-mounted equipment once already integrated into the daily workflow.
If we take this 10% number as the base case, that still sets the dividend up for more low-double-digit annual raises over the years ahead.
Pairing that with the starting yield gets one to a low-teens type of annualized total return.
It’s a lot more of the same, and the same has been terrific.
Financial Position
Moving over to the balance sheet, Motorola has a good financial position.
Its long-term debt/equity ratio is 3.5, while the interest coverage ratio is over 8.
The former number is artificially high, skewed by low common equity (rather than a high debt load).
Motorola ended last fiscal year with just over $8 billion in L-T debt, which is not overly material for a company of this size.
The company also maintains a healthy, investment-grade credit rating of BBB from S&P.
I certainly wouldn’t mind seeing a better balance sheet, but I’m also not seeing anything all that concerning here.
Profitability is very strong.
Return on equity is N/A due to the common equity, but net margin has averaged 16.1% over the last five years.
Net margin has steadily expanded from a low-teens area to a high-teens area over the last decade as Motorola has continuously increased its software and services as a portion of revenue.
ROIC is routinely north of 20%, which is fantastic.
Overall, Motorola has a terrific business on its hands.
And with economies of scale, switching costs, “sticky” hardware reinforced with in-house software and services, barriers to entry, R&D, IP, brand recognition, and established government relationships with entrenched contracts, 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.
I actually view all three of these key risks as modestly subdued for Motorola relative to the average business.
Motorola is heavily reliant on government spending, in general, as a large number of its clients are government agencies.
Input costs can be volatile.
Motorola has some exposure to geopolitics and exchange rates.
Motorola’s size and dominance, while advantages, may start to introduce the law of large numbers.
The very business model may actually be the biggest risk of all, as Motorola is a technology company that must constantly innovate in order to avoid disruption or obsolescence.
The balance sheet isn’t as strong as it could be, which may limit flexibility in the future.
While there are some risks to consider, Motorola’s high level of quality seems to more than overcome all of it.
And the valuation, while seemingly rich in a vacuum, may not fully account for the quality present…
Valuation
The stock’s P/E ratio of 35 is definitely at the high end of what you’ll typically see in any of my features, but I think this is a case where it’s justified.
First, that’s slightly lower than its own five-year average of 36.
Second, that average has been steadily creeping higher due to Motorola’s ongoing shift to higher-margin software and services.
Motorola has taken an excellent hardware business and built on top of it an excellent software business.
It’s rare and remarkable.
Sure, I’d love to see this stock at an earnings multiple of 15 or something, but I just don’t think that’s realistic at all.
It’s not super cheap or anything like that, but it’s at the lower end of what the market has been offering up over the last five years or so.
And the yield, as noted earlier, is in line with its own five-year 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 13%, and a long-term dividend growth rate of 8%.
I’m basically extrapolating out the 10-year dividend growth rate into the next decade, which I think is a perfectly sensible thing to do.
After all, Motorola has been shockingly consistent with double-digit dividend growth, and the near-term forecast for double-digit EPS growth, combined with the payout ratio being where it’s at, easily sets the dividend up for more of the status quo.
Assuming low-teens dividend growth is something I reserve only for really great businesses, but I think Motorola qualifies for the benefit of the doubt.
The DDM analysis gives me a fair value of $398.34.
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.
To me, Motorola’s valuation looks to be in the neighborhood of what’s reasonable.
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 MSI as a 4-star stock, with a fair value estimate of $480.00.
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 MSI as a 4-star “BUY”, with a 12-month target price of $450.00.
I’m clearly on the low end here, so maybe I’m just being overly conservative. Averaging the three numbers out gives us a final valuation of $442.78, which would indicate the stock is possibly 2% undervalued.
-Jason Fieber
Note from D&I: How safe is MSI‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 61. 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, MSI’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 have no position in MSI.