Building wealth, passive income, and freedom needn’t be complicated.
Nothing exotic is required.
In fact, the exotic is oftentimes exactly what gets people into trouble.
Timeless business models selling the products and/or services humans keep buying can be some of the best long-term investments of all.
This basic idea is at the heart of dividend growth investing – a long-term investment strategy which prioritizes buying and holding shares in world-class businesses sending out safe, growing dividends to shareholders.
Safe, growing dividends often emanate from simple, timeless businesses that are just so good at consistently growing the profit necessary to afford paying out ever-larger cash dividends.
You can see what I mean by pulling up the Dividend Champions, Contenders, and Challengers list.
This list has compiled invaluable information on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
Again, you’ll just see one household name and simple business model after another.
I’ve used this line of thinking with my own investments over the years, allowing dividend growth investing to guide me as I’ve gone about building the FIRE Fund.
That’s my real-money portfolio generating enough five-figure passive dividend income to live off of.
I’ve been in the very fortunate position of being able to do so since I quit my job and retired in my early 30s.
Now, while investing in timeless businesses can be a great start, there’s also the matter of valuation at the time of making any investment.
And that’s because price is only what you pay, but value is 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.
Favoring undervalued high-quality dividend growth stocks over the exotic is a fantastic way to approach building sustainable wealth, passive income, and financial freedom over time.
Of course, being able to spot possible undervaluation first involves having a full understanding of what valuation is all about.
Well, that’s where Lesson 11: Valuation comes in.
Put together by fellow contributor Dave Van Knapp as part of a series of “lessons” on dividend growth investing, it spells out the basics of valuation using very easy-to-understand terminology.
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…
Public Service Enterprise Group, Inc. (PEG)
Public Service Enterprise Group, Inc. (PEG) is an American energy company.
Founded in 1903, Public Service Enterprise Group (hereon referred to as PSEG) is now a $36 billion (by market cap) utility employing around 13,000 people.
This is a New Jersey-based electric and gas utility company serving approximately 2.4 million electric customers and nearly 2 million gas customers in the Mid-Atlantic region (but mainly New Jersey).
PSEG caters to commercial, industrial, and residential customers.
The company has two operating units: PSE&G (the primary utility business), 86% of FY 2025 adjusted operating earnings; and PSEG Power (its wholesale arm), 14%.
As we can see, this is largely an old-school regulated power utility business.
That’s an attractive business model for long-term investors thanks to its predictability, necessity, visibility, and resiliency.
After all, its millions of customers are captive.
They literally cannot live without the company’s utilities in a modern-day society.
Plus, since power utilities in the US run localized monopolies, locked-in customers usually have no choice but to buy power from the local provider.
This is off-the-charts “stickiness”.
And power utilities have viable paths toward consistent growth thanks to regulators that allow for reasonable rates of return on investments, whereby rates get scaled up alongside CapEx over time.
However, that regulatory framework can be a double-edged sword, as this “floor” on profit also comes attached with a “ceiling” that legally limits just how much power utilities can charge customers (otherwise, it’d be almost too easy to take advantage of people).
Overall, power utilities in the US like PSEG have been reliable vehicles for revenue, profit, and dividend growth for decades, and I don’t see any of that changing.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Indeed, PSEG has increased its dividend for 15 consecutive years.
Its 10-year dividend growth rate of 4.9% is somewhat middling, but I don’t think that tells the whole story.
What’s been happening here is, dividend growth has been speeding up.
The five-year DGR is 5%.
And the most recent dividend raise came in at 6.3%.
The dividend growth paradigm in this case has been slowly shifting, now leaning toward a high-single-digit rate.
That gets paired with the stock’s market-smashing 3.7% yield.
This yield, by the way, is 50 basis points higher than its five-year average.
That’s faster dividend growth and a higher starting yield.
Not bad at all.
The payout ratio, which is 66.7%, indicates no troubles at all with the affordability of the dividend.
It’s just a solid overall dividend package.
Revenue and Earnings Growth
As solid as it may be, though, much of this is rooted in the past.
However, investors must always be fixated on 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 be of service 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.
Lining up the proven past with a future forecast in this manner should provide us with the ability to estimate where the business could be going from here.
PSEG advanced its revenue from $9 billion in FY 2016 to $12.2 billion in FY 2016.
That’s a compound annual growth rate of 3.4%.
Pretty standard top-line growth for a regulated power utility.
Meantime, earnings per share rose from $1.75 to $4.22 over this period, which is a CAGR of 10.3%.
This is rather strong, and we can now see where the accelerating dividend growth has been coming from.
I’d note that PSEG’s outstanding share count is roughly flat over this period.
This shows more discipline with the capital structure relative to some large US power utility peers, allowing for regulatory wins to bleed right down to the bottom line.
Looking forward, CFRA believes that PSEG will deliver a 9% CAGR in its EPS over the next three years.
While this would trail PSEG’s 10-year proven EPS CAGR, it would still be an excellent and above-average rate of growth for a US power utility.
CFRA specifically calls out PSEG’s differentiation, pointing to solid execution without constant dilution.
CFRA also highlights that PSEG’s $24 billion to $28 billion capital plan for 2026 through 2030 supports management’s 6% to 8% EPS CAGR target through 2030.
The midpoint 7% mark would represent very respectable growth for the business model.
And this could prove to be a conservative target, considering increasing electrification and the buildout of data centers across the US (which boost demand for power in local vicinities).
Putting it all together, I think it’s quite reasonable to expect high-single-digit EPS and dividend growth out of PSEG for the foreseeable future.
Layering that on top of the starting yield paints the picture of a low-double-digit type of annualized total return from here.
When that’s coming out of a predictable, durable business with lots of revenue visibility, it’s an awfully nice setup.
Financial Position
Moving over to the balance sheet, PSEG has an okay financial position.
Its long-term debt/equity ratio is 1.3, while the interest coverage ratio is right about 3.
While management did an admirable job holding the line on dilution, L-T debt has more than doubled over the last decade.
The balance sheet is not exceptional in any way; it’s pretty standard for a large power utility relying on debt to fund growth CapEx.
The company’s investment-grade credit ratings are also par for the course: Baa2, Moody’s; BBB, S&P.
Profitability is rather strong.
Return on equity has averaged 8.9% over the last five years, while net margin has averaged 12.2%.
Return on equity, which is the primary way to gauge profitability and investment recovery for a power utility, has recently been hovering around the 12% area.
That’s impressive and indicative of a friendly regulatory environment.
The five-year average was brought down by an anomalous 2021; otherwise, it’s routinely among the highest figures I’m aware of among US power utilities.
PSEG is just a well-rounded, sound power utility business consistently operating at a high level.
And with economies of scale, a monopoly over its territories, extremely high barriers to entry, a supportive regulatory environment, and a captive customer base, 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 basically non-existent at a local level, regulation is a constant pressure point.
And that regulation is a double-edged sword: Regulators allow for utilities to make a reasonable profit, where profit scales with costs, putting a profit floor in place; however, because electricity is a basic necessity and there’s often only one power provider in any one geographic area, regulators put a profit ceiling in place by limiting the rates a utility can charge.
Also, although competition at a local level doesn’t exist, it’s possible that customers will increasingly become competitors by generating power at the site of consumption (via solar installations).
PSEG is largely dependent on the evolving regulatory structure and population growth of New Jersey.
There is some natural disaster risk present, as well as nuclear risk.
The balance sheet is stretched, but this is offset by highly recurring and predictable revenue.
These risks are pretty average for a power utility.
But PSEG strikes me as an above-average operator, and its valuation doesn’t appear to fully reflect that…
Valuation
The P/E ratio has dropped to 18.4 after a recent 15% pricing correction.
That’s roughly in line with its own five-year average, but it’s below where a lot of lesser utilities are trading at now.
The P/CF ratio of 10.2, on the other hand, is well below its own five-year average of 13.1.
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 7%.
PSEG has been moving toward a 7% dividend growth rate already.
This hits the midpoint of management’s forward-looking EPS growth guidance, which should easily allow for like dividend growth over the years ahead.
I’m not stepping out on a limb here.
This is squarely in PSEG’s strike zone.
The DDM analysis gives me a fair value of $95.59.
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, this stock looks inexpensive after the recent pullback.
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 PEG as a 3-star stock, with a fair value estimate of $75.00.
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 PEG as a 3-star “HOLD”, with a 12-month target price of $86.00.
I’m on the high end this time around, which is a change from recent features. Averaging the three numbers out gives us a final valuation of $85.53, which would indicate the stock is possibly 13% undervalued.
Bottom line: Public Service Enterprise Group, Inc. (PEG) is one of the better US power utility businesses I’ve had the pleasure of analyzing. Great growth. Relatively high returns on capital. And consistent execution. With a market-smashing yield, high-single-digit dividend growth, a reasonable payout ratio, 15 consecutive years of dividend increases, and the potential that shares are 13% undervalued, this is a prime candidate for long-term dividend growth investors seeking to increase their utility exposure.
-Jason Fieber
Note from D&I: How safe is PEG‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 99. 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, PEG’s dividend appears Very 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 PEG.
