Investing is something that’s so easy to overcomplicate.
But at its core, it’s remarkably simple.
That’s even true when talking about stocks.
After capital formation (i.e., living below your means and saving), it’s really just a matter of allocating capital to great businesses that can compound your money at high rates over the long run and reward you with ever-larger cash payments along the way (so that you have income to cover the bills).
That’s most of the game right there.
And this is why dividend growth investing is so effective.
It’s a long-term investment strategy prioritizing high-quality businesses rewarding shareholders with reliable, rising cash dividends.
You can find hundreds of examples over at the Dividend Champions, Contenders, and Challengers list – a fantastic resource naming US-listed stocks that have raised dividends each year for at least the last five consecutive years.
These are some of the best businesses in the world.
After all, those growing dividends are only possible when the underlying growing profits are also in place, and growing profits only come about when a business is doing a lot of things right.
I’ve used this strategy for the last 15+ years.
It’s allowed me to achieve financial freedom and retire in my early 30s.
It guided me as I’ve gone about building the FIRE Fund.
That’s my real-money portfolio generating enough five-figure passive dividend income to comfortably live off of.
While building this portfolio largely involved what I mentioned at the outset of today’s article, there’s a missing piece to all of this that I haven’t mentioned yet: valuation.
See, 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.
Keeping things simple by steadily acquiring undervalued high-quality dividend growth stocks with your savings is an excellent way to build wealth and passive income on the way to eventually achieving financial independence.
That said, the valuation part can be a pain point for some.
If that includes you, make sure to read Lesson 11: Valuation.
Written by fellow contributor Dave Van Knapp, it eliminates a lot of confusion regarding the concept and makes valuation your friend rather than your enemy.
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…
NetEase, Inc. (NTES)
NetEase, Inc. (NTES) is a China-based internet technology company focused on online games, digital services, and premium content.
Founded in 2007, NetEase is now an $80 billion (by market cap) gaming and content ecosystem employing more than 25,000 people.
The company reports results across four segments: Games and Related Value-Added Services, 82% of FY 2025 revenue; NetEase Cloud Music, 7%; Innovative Businesses and Others, 6%; and Youdao, 5%;
As we can see, despite efforts to diversify into other types of content/entertainment, NetEase remains primarily a gaming company first and foremost.
But that’s not necessarily a bad thing.
Gaming is massive globally.
It’s a primary entertainment outlet for millions of people.
And NetEase controls extremely popular releases, such as Fantasy Westward Journey.
Admittedly, a gaming business isn’t every investor’s cup of tea.
The geographic origination will likely only add to a sense of aversion.
While I was initially somewhat put off by the business model and reluctant to cover it in the way I’m doing today, even though it has such high ratings from analysts, a deeper dive into the fundamentals revealed remarkable strength.
I’ve been blown away by just how strong NetEase actually is, which clearly shows up in the company’s revenue, profit, and dividend growth.
Dividend Growth, Growth Rate, Payout Ratio and Yield
The company has increased its dividend for five consecutive years.
That’s in USD terms on the ordinary shares, although the actual ADR dividends can vary quite a bit from quarter to quarter.
What it lacks in some extremely long track record for dividend growth it more than makes up for in terms of the growth rate.
The five-year dividend growth rate is an astounding 26.3%.
Incredibly, the dividend has more than doubled over just the last five years.
Even after all of this growth, the dividend remains easily covered.
The payout ratio, using FY 2025 EPS against the full-year dividend, is 39.1%.
Seeing a payout ratio this low in the face of 25%+ dividend growth already clues us in that the business itself must be growing briskly.
The stock currently yields 2.4%, which is one of the highest yields you’ll come across when you’re also getting such a prolific level of dividend growth.
This yield, by the way, is 70 basis points higher than its five-year average.
It’s a special combination of yield and growth.
Revenue and Earnings Growth
As much as it may be, though, that specialness is mainly based on past information.
However, investors must always be prepared for future information, as the capital of today is put on the line and risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will be of great use when later estimating intrinsic 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.
Blending the proven past with a future forecast in this way should allow us to gauge where the business could be going from here.
NetEase moved its revenue from 38.2 billion RMB in FY 2016 to 112.6 billion RMB in FY 2025.
That’s a compound annual growth rate of 12.8%.
Excellent top-line growth.
Meanwhile, earnings per share advanced from 3.51 RMB to 10.48 RMB over this period, which is a CAGR of 12.9%.
Again, excellent.
This is a fairly large company, so posting up low-double-digit top-line and bottom-line growth is pretty impressive.
Looking forward, CFRA sees NetEase compounding its EPS at an annual rate of 9% over the next three years.
While this would be a really good rate of growth, it would trail the company’s longer-term performance.
I think it’s sensible to scale back expectations and err on the side of caution in this case.
After all, it’s challenging to map out this kind of business model.
The predictability just isn’t there in the same way it is with, say, a utility.
And the long-term resiliency is also questionable.
CFRA is enthusiastic about the company’s core gaming franchises, pointing to momentum across titles such as Where Winds Meet, although CFRA also notes that NetEase has, thus far, been unable to successfully diversify the firm away from gaming in any kind of meaningful way.
If we look at more recent numbers, NetEase posted 14% YOY EPS growth for FY 2025 – an acceleration relative to its longer-term trend.
I’d also quickly highlight that NetEase is a founder-led business.
CEO Ding Lei, who founded NetEase, owns nearly half the company, meaning there’s a lot of common shareholder alignment and “skin in the game” from management.
Nobody could be more motivated to see this company succeed than the key shareholder, and nobody is more empowered to make that happen than the CEO.
Balancing out the strong proven performance against the inherent unpredictability, I’m inclined to agree with CFRA’s near-term stance.
Combined with the low payout ratio, that easily positions NetEase to continue handing out double-digit dividend raises.
And stitching it all together, I think that’s creating fertile ground for a double-digit annualized total return from here.
Financial Position
Moving over to the balance sheet, NetEase has a stellar financial position.
The company has essentially no long-term debt.
Moreover, it ended FY 2025 with $23.4 billion in net cash.
To put that in perspective, it’s nearly 30% of the entire market cap of the company.
This is a phenomenal balance sheet.
Profitability is outstanding.
Return on equity has averaged 22.2% over the last five years, while net margin has averaged 25%.
ROIC is routinely in the 20% area.
NetEase is generating fat margins and very high returns on capital, which are hallmarks of a high-quality business.
Overall, despite my reluctance regarding the core business model, NetEase has terrific fundamentals indicative of a world-class business.
And with economies of scale, an established ability to consistently bring successful titles to market, a wide and popular library, 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.
Competition is especially brutal in this particular space, and new competition may be on the horizon via AI (which could be capable of creating virtual worlds and customized games in the near future).
The very business model is a risk unto itself, as producing hits can be an unpredictable venture not easily predicated on quantifiable and repeatable processes.
Gamers’ tastes change over time, which is something the company must be able to keep up with.
Technology is changing rapidly, which is a key risk.
NetEase has exposure to geopolitics and exchange rates.
Speaking of geopolitics, the company’s China base introduces more geopolitical risks than the average investment for an American investor.
I see NetEase as having an above-average set of risks.
But the stock’s below-average valuation goes a long way toward compensating for all of that…
Valuation
The P/E ratio is now down to 16.2 after a recent near-20% slide in the stock.
That’s well below its own five-year average of 18.3.
It’s also low relative to the quality and growth of the enterprise.
That puts the PEG ratio at around 1, which typically offers an excellent entry point.
The P/CF ratio of just 13.3, which is undemanding on its own, is also lower than its five-year average of 14.8.
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 two-stage dividend discount model analysis.
I factored in a 10% discount rate, a 10-year dividend growth rate of 10%, and a long-term dividend growth rate of 7%.
I’m being ultra conservative in this case.
The business model simply isn’t as predictable as what I’m used to, making it more challenging to model out longer-term growth rates.
That said, NetEase has, to date, defied all critics and delivered incredible results, so I’m willing to give the company the benefit of the doubt.
I’m assuming dividend growth over the next decade tracks somewhat similarly to the last few years, albeit at a slower rate.
I’d then expect a material slowdown thereafter, simply because it’s too difficult to tell how many hits the company is going to be able to come up with a decade out.
With the payout ratio being so low and the cash pile being so massive, NetEase could sustain high levels of dividend growth for many years without much business growth, which I think does offer a nice angle and a margin of safety.
The DDM analysis gives me a fair value of $137.91.
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.
Even after a lot of caution, the stock comes out looking inexpensive.
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 NTES as a 4-star stock, with a fair value estimate of $200.00.
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 NTES as a 3-star “HOLD”, with a 12-month target price of $128.00.
Morningstar’s enthusiasm surprises me a bit. Averaging the three numbers out gives us a final valuation of $155.30, which would indicate the stock is possibly 18% undervalued.
Bottom line: NetEase, Inc. (NTES) is a terrific, founder-led business with a stellar balance sheet, juicy margins, and high returns on capital. If the company can continue to deliver successful titles to market, shareholders stand to do very well over time. With a market-beating yield, double-digit dividend growth, a low payout ratio, five consecutive years of dividend increases, and the potential that shares are 18% undervalued, this is an interesting idea for more adventurous long-term dividend growth investors.
-Jason Fieber
Note from D&I: How safe is NTES‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is unrated. 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.
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 NTES.
