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This Future Dividend Aristocrat Is The Best Way To Cash In On The Coming EV Boom

Posted On July 26, 2018 11:49 am
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Dividend Profile: Safe And Fast Dividend Growth Means Market Crushing Return Potential

Company Yield TTM Payout Ratio Projected 10 Year Dividend Growth Rate Potential 10 Year Annual Return
Albemarle 1.5% 27% (Very Safe) 12.1% 13.6%
S&P 500 1.8% 40% 6.2% 4% to 8%

(Sources: Morningstar, Simply Safe Dividends, Gurufocus, FastGraphs, Gordon Dividend Growth Model, Multpl, Vanguard)

The most important part of any income investment is the dividend profile, which consists of three parts: yield, safety, and long-term growth potential. Albemarle’s yield is lower than the market’s and certainly not exciting on its own. But what it lacks in current yield it more than makes up for in dividend safety, and strong long-term growth potential.

The company’s dividend safety stems from its low payout ratio, courtesy of its booming earnings and cash flow. In addition it has a fortress like balance sheet to give the dividend a wide safety cushion while allowing the company to aggressively invest in future growth.

Company Debt/EBITDA Interest Coverage Ratio S&P Credit Rating Average Interest Rate
Albemarle 1.9 13.3 BBB 4.1%
Industry Average 2 35.1 NA NA

(Sources: Morningstar, Gurufocus, FastGraphs)

At first glance Albemarle’s relative debt metrics don’t look that impressive relative to its peers. However, the company has a large cash position of almost $700 million meaning that its’ net debt/EBITDA ratio is actually a very low 0.9. This is why it enjoys one of the top credit ratings in the industry and can borrow at lost costs to fund its ambitious growth efforts.

That growth is expected to drive about 12% dividend growth over the next decade. And according to the Gordon Dividend Growth Model (highly accurate since the 1950’s) that should result in impressive 13.6% or so total returns. That’s in line with the company’s total returns over the past quarter century and is about double what the overall S&P 500 is likely to generate over that time from current valuations.

Valuation: A Wonderful Company At A Good Price

Even a great stock can make a bad investment if bought at the wrong price. Fortunately thanks to a 27% decline this year Albemarle is now nicely undervalued. There are several ways to value a stock and none are 100% objectively correct. This is why I use several techniques in concert to build a more robust valuation model and minimize the chances of overpaying for a company. The first is the total return potential from the dividend profile. I only want to recommend stocks that have a good chance of beating the market (otherwise just buy an index fund). And to own a stock personally I’m looking for at least double digit return potential. On both counts ALB passes this first screen with flying colors.

The second method I use is looking at the PE ratio. I both compare it to the long-term (20 year) average and use it to estimate the EPS growth rate baked into a stock based on a model pioneered by Benjamin Graham. Graham was Buffett’s mentor and is the father of modern value investing.

Forward PE Ratio 20 Year Average PE Implied 10 Year EPS Growth Rate Yield 13 Year Median Yield
17.5 17.9 4.5% 1.5% 1.4%

(Sources: Morningstar, Gurufocus, FastGraphs, Benjamin Graham)

Today ALB trades at a slight discount to its 20 year average PE. However, the company’s growth potential was greatly boosted in 2015 thanks to its entering the Lithium market. This means that the company is likely to face multiple expansion in the future. That’s because the current price is baking in just 4.5% long-term EPS growth. With ALB likely capable of nearly three times that growth rate, its total return potential is likely even stronger than what the Gordon Dividend Growth Model projects.

Next I compare the yield to its historical yield (13 year median). That’s because over time yields tend to be mean reverting, or cycle around a relatively fixed point approximating fair value. ALB’s current yield implies that based on this approach the stock is about 7% undervalued.

Finally I sometimes look at a discounted cash flow or DCF model, such as provided by Morningstar. This estimates a stock’s fair value based on the net present value of all future cash flow. Theoretically it’s the purest and most accurate valuation approach. However it’s limitations are the large amount of assumptions required to derive a fair value, including smoothed out growth rates over several decades.  That being said Morningstar analysts are 100% long-term, fundamental focused and notorious for their conservative growth assumptions. This means that their fair value assumption is usually on the low side. Today Morningstar estimates ALB’s fair value at about $120 indicating a 24% margin of safety (discount to fair value).

Taking all these methods together I estimate Albemarle is about 11% undervalued right now. That might not sound like a lot but for a world class industry leading blue chip such as this, I’m more than happy to recommend it at fair value or better. Because as Warren Buffett said “it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”.

This means I can enthusiastically recommend Albemarle today, to any income investor comfortable with its risk profile.

About author

Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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