By: Dividend Sensei
Valuation: One Of The Most Undervalued Stocks On Wall Street
There are dozens of ways to value a stock and none are 100% objectively correct. However, for stable business model blue chips like FDX there are two time tested methods that usually prove accurate.
The first is to look at the forward PE ratio. We can plug this into a fair value formula created by Benjamin Graham, Buffett’s mentor and the father of modern value investing. That formula says that the fair value PE for a stock is: (8.5 + (2X long-term EPS growth rate))/discount rate. The discount rate (in decimal form) is the rate you want to earn on your investments. I use a 10% discount rate for these calculations since that’s superior to the stock market’s historical return (since 1871) of 9.2%.
- Forward PE: 14.2
- 20 Year Average PE: 22.0
- Implied 10 Year EPS Growth Rate: 2.9%
- Analyst 10 Year EPS Growth Consensus: 13.2%
- Conservative Graham Fair Value PE: 19.7
- Conservative Graham Fair Value: $342.5
- Discount To Fair Value: 39%
Currently FedEx is trading at just 14.2 times forward earnings which is far below its 20 year average PE of 22.0. That alone tells us the stock is likely undervalued. And plugging that into Graham’s Fair Value formula we see that FDX shares are currently prices for just 2.9% long-term EPS growth. That’s about four times less than management’s long-term guidance. This seems to imply the stock is not just a good value but a screaming buy. To confirm this let’s take a very conservative approach to determining FedEx’s fair value PE.
Let’s use our 10% discount rate (which alone is designed to ensure market beating returns) and then cut analyst and management growth expectations in half. Even then the Graham formula says this stock should be trading at a forward PE of 19.7 or a price of $342.5. That’s an estimated 39% discount to fair value, even using growth expectations half that of what management thinks are likely.
To confirm that very high undervaluation we can also use another time tested (since 1966) strategy for stable dividend growth stocks. That’s to compare the yield to its historical yield. The reason this works well is because dividend growth blue chips tend to have yields that mean revert or cycle around a relatively fixed point that approximates fair value.
- Yield: 1.1%
- 5 Year Average Yield: 0.7%
- 13 Year Median Yield: 0.6%
- Conservative Estimate Discount To Fair Value: 37%
FedEx’s five year average and 13 year median yield are nearly identical confirming that this approach is suitable for analyzing this stock. Again taking a conservative approach let’s assume that FDX’s yield in 10 years will rise by 0.1% just as it did over the past decade. This means that over time, Fedex’s yield should drop to 0.8% as the market prices it purely on its strong and growing fundamentals (earnings and cash flow growth). In that case the stock is about 37% undervalued which is nearly identical to the conservative Graham Fair value estimate.
- Estimated Fair Value: $398
- Discount To Fair Value: 38%
- Long-Term Valuation Total Return Boost: 4.9%
Combining these two valuation models I estimate FedEx to be about 38% undervalued right now. Over time valuations tend to mean revert meaning that over the long-term the stock will likely approach fair value. From the current fire sale price that mean reversion would likely create a 4.9% annualized total return boost which is how FedEx might achieve 18% total returns (1.1% yield + 10% to 15% dividend growth + 4.9% multiple expansion). Keep in mind that this potential total return is about double the market’s historic return and likely three to four times what the S&P 500 is likely to deliver in the coming years. This is what makes FedEx one of the best blue chip dividend growth stocks you can buy today. That is assuming you are comfortable with its risk profile.