3 Dividend Growth Stocks with Wide Margins of Safety

The recent drop in the stock market is opening doors to many opportunities. While some investors have felt the heat and decided to abandon ship, others may just find a perfect entry point to make new purchases.

In such volatile markets, wise use of a margin of safety becomes one of your best tools to make the right investing decision. Remember that during a correction, not all stocks are trading at discounts – some of them are simply bad investments and won’t recover.

The difference between catching a falling knife and buying a strong but undervalued company with a margin of safety is a thin line. The whole process behind analyzing a company is crucial and this is where valuation comes into play.


What is a Margin of Safety?

Before using the margin of safety, an investor must be able to evaluate the shares he is looking at. The goal is always to buy undervalued companies if you are looking to make strong profit. A good way to determine the value of a share is to use a dividend discount model. It is a relatively simple model and it’s easy to use. It will help you put a dollar value on a company and its ability to generate dividend payments.

The margin of safety happens once you have determined a value for a company XYZ. Let’s assumed you have made your calculations and you found that company XYZ’s shares should trade at $10. This is known as its “intrinsic value”. The “$10” is found based on your stock analysis and dividend discount model. Then, if the company stock is currently trading at $9, you benefit from a 10% discount; this is your margin of safety. In other words, while you think the company should be worth $10 a share, you can be wrong in your calculation up to $1 difference since the company is currently trading lower.

Warning, a wide margin of safety could mean two things:

#1 You found a great buying opportunity

#2 Your calculations are completely off and you missed something about the company’s situation or business model.

In order to show you real life examples, I’ve selected three interesting buys with wide margins of safety:


BlackRock (BLK)

It’s a bad month for the market, and it also affected greatly BLK’s stock price. The concerns come from a general doubt around the industry of investment firms. Typically, this sector is making the bulk of their revenue from fees charged on the assets they manage (called assets under management – AUM). If the market drops, AUM will follow accordingly and fees charged will naturally decline. In addition to this situation, investors have the awful reflex to withdraw part of their money from the market when it drops. This pushes the AUM even lower. However, this recent drop in price is more likely to be a great entry point to buy this leader in the ETF industry. BLK’s leadership position as the largest investment firm combined with its ability to generate higher profitability than its peers makes it a great company to buy. The company is currently trading with a 20% margin of safety:

BLK intrinsic value

Caterpillar (CAT)

Among my three examples, CAT is probably the one that is closest to a falling knife and where the margin of safety could be a lure. I personally believe in the company’s leadership position in its sector. While the company could benefit from the solid construction industry in the US, this is about the only good news for the upcoming months.

Caterpillar announced another 10,000 layoff round after cutting 20,000 jobs back in 2009. The problem is that the mining industry is dropping like rock ;-). Nonetheless, now that the company is trading at a PE ratio under 11 and showing a dividend yield close to 5%, it could be a very interesting addition to your portfolio.

CAT intrinsic value

3M Co (MMM)

MMM is a great example of a good company with a falling stock price that is following the overall market without any good reason. The stock price has followed exactly the same foot steps as the S&P 500 since August.

However, the company shows a stellar balance sheet, awesome product and geographical diversification and a strong ability to increase its dividend payment in the upcoming year. If you pick it up now at a yield of nearly 3%, you will just make a steal off the market.

MMM has recently dropped to a 20% margin of safety. You can rarely pick shares of MMM at a 3% dividend yield.

MMM intrinsic value

How To Calculate your Margin of Safety

As you can see, I use a 15 cell discount model matrix. The Dividend Discount Model I use comes with a two stage dividend growth rate. A first one is used for the first 10 years and you have the option to change it for the years after. Then, the calculations are made for you automatically and generates 15 possible values for the same stock price analysis.

This helps you to put into perspective the effect of different discount rates and dividend growth rates used in your calculations. The spreadsheet is offered in my Dividend Toolkit package (you can read more about it here):

dividend toolkit

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Canadian National Railway – Trading on both markets, Great Opportunity


15% CAGR dividend growth rate over the past 5 years and the company still has plenty of room to reward investors.

Both Revenues and Earnings show double digit growth over the past five years.

Strong management with conservative cost control approach makes this money making machine even stronger.

DSR Quick Stats

Sector: Industrial – Railroads

5 Year Revenue Growth: 11.22%

5 Year EPS Growth: 14.64%

5 Year Dividend Growth: 15.40%

Current Dividend Yield: 1.71%

What Makes Canadian National Railway (CNI (CNR.TO)) a Good Business?

Founded in 1918, Canadian National Railway is the largest railway in Canada and has significant operations in the United States. The rail network extends from the Atlantic to the Pacific Ocean through Canada, and also extends southward to the Gulf of Mexico through the United States. The total mileage of track exceeds 20,000. The company trades on both Canadian and US markets under CNR.TO and CNI tickers.

The company is divided into seven commodity groups:

-Petroleum and Chemicals

-Metals and Minerals

-Forest Products


-Grain and Fertilizers




Price to Earnings: 16.08
Price to Free Cash Flow: 26.60
Price to Book: 3.934
Return on Equity: 24.06%


CNI revenueRevenue Graph from Ycharts

Revenues were slightly lower in 2015 for the first time since 2010 due to less economic activity around coal, grain and crude oil. The global shift toward cleaner energy will continue to hurt the demand for coal, but the company should benefit from higher activity in the forest industry since the CAD is ever lower compared to the USD.

How CNI (CNR.TO) fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies using various sources. This is how I came up with my 7 investing principles of dividend investing. The first four principles are directly linked to company metrics. Let’s take a closer look at them.

CNISource: Ycharts

Principle #1: High dividend yield doesn’t equal high returns

I’m usually not a big fan of high yield dividend stocks, but I’m not a huge fan of low yield dividend stocks either. Financial research has proven that stocks with yield in the 2nd highest quartile outperform the others. Therefore, my target for a strong dividend stock is usually between 2% and 5%. CNI fails to meet this requirement:

CNI div paid yieldSource: data from Ycharts.

On the other hand, the dividend growth is quite impressive. This is why I have decided to look into this company further.

Principle#2: If there is one metric, it’s called dividend growth

Speaking of dividend growth, CNI is probably one of the best examples of a Canadian dividend growth stock. By the nature of its business model, railway companies produce important levels of cash flow leading to strong ability to increase dividend payouts. Over the past 5 years, the company has a dividend growth rate over 15% annually. At this rate, the dividend payment will double every 5 years.

Such strong dividend growth perspective is fueled by ever increasing revenues and profits. Without such a strong base, a company wouldn’t be able to open the dividend reservoir that wide.

Principle #3: A dividend payment today is good, a dividend guaranteed for the next ten years is better

The real question is; can Canadian National Railway keep increasing its dividend at this pace? Here is how the dividend payment and the payout ratio have looked like over the past 10 years:

CNI payout ratio

As you can see, the payout ratio is steadily increasing from a low of 16% in 2007 to 27% in 2015. However, the company could easily keep up with a 10% dividend increase for several years with such low payout ratio.

Principle #4: The Foundation of dividend growth stocks lies in its business model

The company’s business model is strong as they serve many different industries. This makes CNI able to switch from coal, grain and crude transportation to lumber & panels, chemistry and automotive transportation in a heartbeat.

The company’s cash flow generating ability has been envied by its peers for years and this makes CNI dividend growth base more solid than rock.

What Canadian National Railway Does With its Cash?

There is nearly 20% of CNI revenue used for railway maintenance. This is probably the biggest downside of such companies is the high cost of maintenance. As trucks can use “free roads” and pipelines require less maintenance, railway companies must take care of their own track.

However, the company is generating over 2 Billion in free cash flow per year. In 2015, the company uses this cash flow to increase the dividend payment by 25%. Management goal is to reach 35% payout ratio in the upcoming years, opening the door for more dividend increases.

Investment Thesis

Railroads serve a critical role in world transportation. They remain the most energy efficient way of transporting large amounts of material far distances. From an investing point of view, railways also have among the very strongest of economic moats, in that they are established businesses where new competitors are scarce. Obstacles to starting up a new railway business are obvious, because once track is put down to serve an area, duplicate track would be a poor investment.

The company has several strong indicators:

-None of the seven commodity groups account for more than 20% of revenue, which is solid diversification.

-Further evidence in terms of diversification; 18% of revenue comes from U.S. domestic traffic, 22% comes from Canadian domestic traffic, 28% comes from trans-border traffic, and 32% comes from international traffic.

Overall, I view Canadian National Railway as a fundamentally solid, albeit cyclical, business. The revenue growth is consistent, free cash flow is fairly strong, and the balance sheet is healthy. The business portfolio has satisfactory diversification and breadth in terms of geography and commodity groups. Railways have natural moats surrounding their businesses. A simultaneous pro/con is that capital expenditure is very regular and increasing. It shows that management is on top of their priorities for long-term sustainable growth, efficiency, and safety, but when this outpaces revenue growth, there is of course a cost.


The company is fairly safe from competitors in my view, so the risks are mainly associated with macroeconomic conditions. The company held up well during the recession but was still materially impacted by it, and this will likely be the case during the next recession as well, whenever it occurs. The company has good safety metrics and as previously mentioned, spends considerable sums on capital expenditures, so catastrophic incidents should be rare. My view is that the company is cyclical, but fundamentally solid on all observable quantitative and qualitative matters.

The global slow down for various commodities at the same time might affect revenues in the near-term but the railways will still be there to benefits from the next economic boom.

Should You Buy CNI (CNR.TO) at this Value?

Now, usually stellar companies command a premium on their stock price. Is it the case for CNI? Let’s take a look at the past 10 years PE ratio to see how the market values the company:

CNI PE ratio

The latest correction in the market seems to have created a very interesting entry point in CNI. The company seems fairly valued at a PE ratio around 16 if we compared the past 5 years.

Since I’m a dividend growth investor, I will also consider the company as a pure money making machine by using the dividend discount model. Since CNI evolves in a fairly stable and predictable market, I will use a discount rate of 9%. As for dividend growth, I use a 10% rate for the first 10 years and reduce it to 7% to be more conservative.

CNI intrinsic valueSource: Dividend Toolkit Calculation Spreadsheet

As you can see, while the stock price has gone up by 77% over the past 5 years, there is still room for more growth. The company is currently undervalued by over 10% which is definitely a great entry point. This gives a good margin of safety for someone considering buying the stock at this time.

Final Thoughts on CNI (CNR.TO) – Buy, Hold or Sell?

Canadian National Railway is not paying the highest dividend yield on the market (1.76%) but it is continuously increasing its payout (400% total increase over the past 10 years) while maintaining a payout ratio under 30%. There is limited competition in this sector and CNR is often cited as one of the best managed railway company in North America. For more conservative investors, CNR will bring more stability coupled with better dividend growth perspectives.


Disclaimer: I hold shares of CNI in our DividendStocksRock portfolios

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Autumn 2015 Dividend Stock Newsletter

This has been an interesting time for markets. China’s market crashed, and global markets around the world responded with milder crashes and volatile rides.

And yet the US still has a highly valued market.

According to historical valuation assessments of the broad market, such as the Shiller P/E, the U.S. stock market is still valued at a premium compared to its historical mean. This is probably partially the result of the unusually long stretch of low interest rates. And when discounted cash flow analysis, or other versions of that like the dividend discount model, are performed on individual stocks, many of them have been valued at a premium lately.

There are a lot of long term problematic trends. Trends that are decades in the making, larger than individual bull and bear cycles in the market. The U.S. has a weak middle class along with increasing political polarization and public debt, Europe has ongoing problems with their shared currency, debt levels, and unemployment, Russia’s economy is in shambles due to their concentration in the energy sector and the fallen energy prices, China’s stock bubble just burst, and Japan has an aging, shrinking population and the world’s highest national debt level as measured by the debt to GDP ratio. These large drivers of the global economy all have substantial long-term problems. And yet U.S. stock market valuations are historically high.

Needless to say, I’m not surprised to see a market correction, and wouldn’t be surprised to see a bigger one on the way. We’re certainly due for one. And yet, I’ll still be putting money into the market. This season’s newsletter will focus on how to build a dividend portfolio to weather economic storms, including some stock ideas I think look reasonably valued at the moment.

Keys to Defensive, Successful Investing

Investing is simple, but not easy. Many investors buy and sell on emotion, as evidenced by the fact that large cash flows into the market are observed to occur at market peaks, and large cash flows out of the market are observed to occur towards market bottoms. I think that readers of dividend sites like this one tend to do better, fortunately. I’m preaching to the choir a bit in this section.

The healthiest, longest lived populations in the world, such as those living in Okinawa Japan or Icaria Greece, tend to have the simplest, most obvious diets and lifestyles. And most of the world doesn’t follow them, despite their simplicity and pleasure. In places like that, the people eat whole fresh food like wild fish and legumes, plenty of vegetables and fruits and herbs and spices, socialize with family and friends as a cultural priority, drink tea or wine in moderation, get plenty of slow exercise from walking to and from their jobs and neighbors homes and doing manual work, and don’t rush or experience much stress. And many of them are dancing and hiking and laughing and staying mentally sharp into their 90’s and 100’s, while spending a fraction of what we do on health care. It’s not complicated for them.

Successful investing is a lot like that. Simple, but rare. Obvious, yet rarely followed.

Check your Balance
This is a good time to check your asset balance. Do you have the ratio of stocks, bonds, cash, and other investments that you target?

Having a diversified portfolio reduces volatility because by ocassionally rebalancing, you’ll naturally shift money from bonds/cash to stocks when stocks are cheaper, and shift money from stocks to bonds/cash when stocks are expensive, simply due to returning to your target balance from time to time.

Invest Over time
If you determine the suitability of an investment by calculating a fair intrinsic value, don’t worry too much about trying to predict the future. If the price is reasonable now, a few months from now might be even better. Or it might be worse. Neither of us know. By putting money into attractively priced investments on a regular basis, you even out your chances.

There are plenty of people I know that dabble in investing as a hobby rather than as a consistent means of building wealth. What this means is that they maintain a little portfolio of some hot stocks, and enjoy discussing performance with colleagues and friends. Five years later, their portfolios are still small, because individual stock performance is a lot less important than shoveling money into a portfolio month after month.

Stock, Country, and Sector Concentration
Consider how much money you’d be willing to lose in a single investment, and then invest accordingly.

Regardless of how prudent we may be, an investment could go sour. We don’t have access to all the current information, nor do we have the ability to see the future. Plus, a shared event could bring down all stock prices in a sector, such as a reduction in the price of a barrel of oil, or a housing bubble. And a single country could have poor governance or economic stagnation. It’s often a good idea to maintain diversification among companies, sectors, and countries.

As long term investors, we don’t really care about stock prices themselves, because all else being equal, low stock prices just mean more buying opportunities. But we do care about tangible financial damage to a company including things that could lead to dividend cuts, so diversification is important.

Concentration into a few companies, or a major sector, could lead to outperformance compared to a diversified portfolio. But it could also lead to disaster, wiping away a decade of portfolio growth. Deep concentration sometimes makes sense for professional investors, but rarely is ideal for casual investors who are building wealth for their families.

Four Stocks to Consider

Texas Instruments (TXN)
Texas Instruments has fallen from a high of nearly $60 down to under $50 per share, and I believe it may be a solid investment at this price level.

Over the last decade, the company has not had any revenue growth, and a big reason was that they completely exited the wireless market to focus on analog and embedded chips, which was a transition they completed in 2013. Despite the lack of revenue growth, the company has increased free cash flow margins and reduced their share count substantially from share repurchases, resulting in 13% free cash flow per share growth over the last decade. They’ve also increased their dividend for eleven consecutive years now. All of their free cash flow goes to dividends and share repurchases, and only 4% of revenue has to be invested back into the company for capital expenditures.

Looking forward, with no major transitions ahead, Texas Instruments is the largest analog chipmaker in the world and should be set to finally grow. In addition, their transition from 200mm to 300mm wafers should cut their costs significantly, further increasing their profit margin. As they continue giving all the free cash flows back to shareholders, investors should do well.

An issue that some dividend portfolios face is that they lack much investment in the technology sector. Dividend growth companies are rare in the sector, and as an investing demographic, we tend to prefer stability. A company like Coca Cola will be selling pretty much the same products ten years from now as they do now, but Apple will be selling absolutely nothing of what they currently sell in ten years. A company that has to continually reinvent itself is harder to predict for the long holding periods that dividend investors tend to prefer.

But a handful of tech companies are blue chip companies with decent dividend payouts, and Texas Instruments is one of them. The dividend yield is currently 2.8% with a high dividend growth rate, and the overall shareholder yield is over 7%. Analog chips, which measure things like temperature and pressure and convert them into digital information, are hard to design, have very long product lifecycles (years, and sometimes decades), and as a result offer high profit margins for the designers. Embedded systems, like microcontrollers, also have long lifecycles and similar profitability levels. If there’s a tech stock out there that’s good enough for a dividend portfolio, the world’s largest analog maker is a top contender.

Chipmakers exist in a cyclical industry, and competition is significant, so Texas Instruments is not without risk.

Using the last twelve months of dividends ($1.36), along with a conservative estimate of 7% dividend growth going forward (quite low, compared to their 13% free cash flow growth per share over the past decade and their high recent dividend growth rate), and lastly a slightly market beating 10% target rate of return (discount rate), we can arrive at an estimate of fair value:


For investors that use options, Texas Instruments is also a decent stock to write a long term covered put for. If you want to pick up shares of the company at a lower cost basis than what is currently available, you can write puts at a strike price you desire, and get paid to wait. For example, you can write January 2017 puts at a strike price of $47, and receive about $6 per share as a premium for doing so. If, in the next 16.5 months, Texas Instruments goes below $47/share, you’ll have to buy at $47/share, and your actual cost basis would be about $41. On the other hand, if Texas Instruments stays above $47, you’ll have been paid a fairly high rate of return simply to wait, without buying, and then you can use your capital elsewhere, or write another put.

Chevron Corporation (CVX)
Chevron stock was absolutely slammed and has since rebounded a bit.

In my previous newsletter from three months ago, I stated that Chevron stock was fairly valued. Not overvalued or undervalued, but fair. A couple months after I wrote that, crude oil prices dropped like a rock from $60/barrel to $40/barrel, which naturally brought oil stocks down, including Chevron. This is an example of where not putting too much money into one stock, and having a habit of investing money every month, helps ease things a bit. Recently, crude went back up to about $50, easing Chevron’s problems.

Chevron is in a particularly vulnerable state, because they have a high dividend payout for the industry, and they’re right in the middle of an investment cycle where they are spending a lot of money on investments and waiting for large LNG projects to fully come online and start producing major revenue. Having oil prices fall and their profit cut away, is a major blow to the company.

The big question for dividend investors is whether or not the dividend is safe. The company has raised its dividend for 27 consecutive years and now is being looked at as a potential dividend cut. After this stock price drop, the dividend yield is at a lofty 5.3%.

The official position of the company, based on their most recent investor presentation and words from their chief financial officer during the last earnings announcement, is that their number one priority is to cover the dividend with free cash flow by 2017. This is because their major LNG investments are coming online, and capital expenditures are expected to fall dramatically when their period of massive investment will be finished, and the fruits will be harvested. The next year and a half though, until 2017, will be rough. At these oil prices, free cash flow won’t cover the dividend, and so the company is issuing debt to pay for it. Obviously that’s not sustainable.

The company currently has about $30 billion in long term debt, and shareholder equity minus goodwill of about $150 billion. This is a LT debt-to-equality ratio of about 20%, which is a very strong balance sheet. The company currently pays out about $8 billion per year in dividends, so if the company uses debt to fund the dividend for 18 months, that would require about $12 billion. This would boost long term debt to $42 billion for the dividend alone, resulting in a LT debt-to-equity ratio of around 30%, which is still a very strong balance sheet. As a comparison, Conoco Phillips currently has a LT debt-to-equity ratio of about 50%. So, Chevron could fuel its dividend with debt until its LNG operations help it fully cover its dividend with free cash flow in 2017, and still have a stronger balance sheet than Conoco Phillips.

Does Chevron have to cut its dividend? Absolutely not. Will they? Who knows. In a world without dividend champion lists, and investors that rely on dividends for income, cutting the dividend for a year or two and then restarting it at a higher rate when they are in a better position, would be financially prudent. But when reputation matters, the executives seem as though they want to hold onto it.

The way I see Chevron currently, is that gas prices won’t stay this low forever, and five years from now, Chevron at $80/share or Exxon Mobile at $75/share will be seen as steals. But in the near term, a dividend cut is not out of the question, especially for Chevron. I wouldn’t rely on Chevron for current income, but I’d look at it as a potential bargain stock for the long haul.

Toronto-Dominion Bank (TD)
The Canadian housing market is highly priced, and Canadians have record levels of household debt relative to disposable income, at over 160%. This is higher than US household debt levels right before the housing crash in the mid 2000’s, when we were at 130% on average, down to under 110% now after some household deleveraging.

Vancouver is a particularly interesting case, because much of the demand for housing comes from outside their local labor market. A significant chunk of luxury property in the city is purchased by people from mainland China, and many Chinese people just lost a lot of wealth on paper from their stock market crash.

Plus, oil prices have fallen far, and Canada’s economy has a lot of concentration in this sector. If there’s something that could cause a housing bubble to burst, something like this might do it.

Needless to say, some investors are shorting companies that have exposure to the Canadian housing market. I can see why. And yet, I don’t think investors necessarily have to avoid this industry. TD in particular is in a decent position.

The Canadian banking system works in a fundamentally different way than the US banking system. In Canada, it’s a lot harder to simply walk away from a mortgage when the price of a house drops. As a result, even before the U.S. housing crash, Canadians have had a much lower rate of mortgage delinquency than Americans. In addition, many residential mortgages held by Canadian banks are insured by the government, limiting their own losses.

Toronto Dominion bank is one of the largest banks in Canada, and is the sixth largest bank in North America. Their business model involves borrowing money mainly from depositors and lending that money at higher interest rates to customers for mortgages, auto loans, and other types of loans. The bank has expanded strongly into the United States along the east coast, resulting in the bank having 15 million Canadian customers and 8 million American customers and growing. The bank’s focus is on retail banking, aiming to offer top quality customer service compared to competitors. At a time when banking is starting to shift from physical to online banking, TD is going against that trend by focusing on expanding their physical footprint and offering longer banking hours than competitors.

Compared to their peers, TD has a larger portion of their Canadian mortgages insured. Slightly over 2/3rds of their Canadian residential mortgages are insured. For that other third, the average mortgage-to-value of the loans is 70%, meaning that a fairly large housing correction would have to occur before those mortgages would be underwater. Unfortunately by some estimates, the Canadian housing market may indeed be that far overvalued, with that far to fall. Overall though, it can be said that TD is in a stronger position than American banks were before the US housing crisis, and is also in a stronger position than many of the other large banks in Canada. The credit agencies currently assign TD bank with high credit ratings (Aa1, AA-, and AA respectively by Moody’s, S&P, and DBRS), and those credit agencies are taking into account the risks embedded in the current Canadian housing market.

Historically, TD’s performance has been excellent. The company has had 12% average dividend growth over the past 20 years, and currently has a solid 3.8% dividend yield. Over the past 10 years, the bank’s revenue has climbed from under 12 billion CAD to over 30 billion CAD, while EPS has grown at a similar rate, despite some share dilution.

Their most recent investor presentation states that the bank expects to increase adjusted EPS by 7-10% per year over the medium term. In combination with a nearly 4% dividend yield, this is a good potential investment. However, given the state of household debt and housing prices in Canada, I’ll use a more conservative growth estimate in my dividend growth expectation.

Here’s the estimated fair value, in CAD, using a 6% long term dividend growth rate and a 10% discount rate:


That’s in CAD on the TSE, not in USD on the NYSE. Currently, the price is about equal to the estimated fair value. And that’s using a dividend growth rate that is below the low end of the company’s estimated EPS growth rate; 6% compared to 7-10%, because I’d prefer to be pessimistic on this. If you believe the company will hit its estimates, or if you’re willing to settle for a lower 8% or 9% rate of return, the fair value to you would be substantially higher than the current price.

Overall, I believe TD represents a fair buy at this time. There are risks in the Canadian housing market, but the stock is trading at a price that seems to take that into account. TD has protection in the form insurance for a majority of its residential mortgage portfolio as well as diversification into the US lending market.

Aflac Incorporated (AFL)
Aflac sells supplemental health insurance in the United States and Japan. While primary health insurance companies will cover various specific procedures, usually by paying the health care provider rather than the policyholder, Aflac’s main business model instead is to pay cash to policyholders that file claims for certain health problems, like cancer. This way, when customers face income loss or other financial problems due to a health problem, Aflac provides them with cash to get through those difficult times while their primary health insurance company covers the actual medical expenses.

The company experienced strong top line growth between 2005 and 2012, climbing from $14.3 billion in revenue to $25.3 billion in revenue. During that time, the dollar was weakening compared to the yen, giving the company a strong tailwind. Then, from 2012 to now, the revenue has fallen from that height of $25.3 billion to $21.7 billion, this time due to the dollar strengthening compared to the yen, giving the company a major headwind. EPS has followed a similar pattern over that period of time.

So, this has been a tough few years for Aflac. The positive part of the story, however, is that their core business is doing very well when exchange rates are excluded. Between 2005 and 2014, the amount of premiums they have generated in Japan has increased every single year, from about 1 trillion yen in 2005 to about 1.6 trillion yen in 2014. The story is similar for their US business; premiums have increased from $3.7 billion to over $5.6 billion during that period, and every single year saw an increase in premiums compared to the previous year.

Japan has an aging population, and the universal health care system is conservative in its payouts. Japan has the longest life expectancy in the world and pays considerably less than half of what the US pays per capita on health care each year. This gives Aflac plenty of room for continued growth for the forseeable future, because their role as a supplemental insurer should only grow stronger.

The long-term bearishness of Japan’s economy, along with their very high national debt, is a risk to be aware of. However, Japan’s debt is held in its own currency to its own citizens, giving the country considerable flexibility in avoiding default in most foreseeable scenarios.

Although predicting exchange rates is not something I care to do, the fact that the dollar has already had a four-year surge relative to the yen (going from fewer than 80 yen per dollar in 2012 to over 120 yen per dollar currently in late 2015), and the dollar has surged relative to foreign currencies in general, implies that the company probably doesn’t have too much to worry about from continued currency headwinds over the long term, at least. I believe the worst of their currency troubles are probably behind them, and if not, the company is doing fine anyway, albeit with reduced profitability, and they can safely ride out the currency problems.

Aflack stock currently trades for a P/E of just under 10. They have raised their dividend for 32 consecutive years, but their payout ratio is on the low side, and the dividend yield is about 2.7%. They also repurchase a lot of shares, and between 2005 and the current quarter, their total share count has fallen from 508 million to 444 million. This is a business model I like; a large portion of the returns comes from the dividend and from the company reducing its share count by buying cheap shares, while also enjoying moderate premium growth and a growing customer base in two countries.

Aflac’s dividend has historically risen at a double-digit rate, but during the recent problem with currency exchange rates, Aflac’s dividend growth rate has fallen below 6%. In 2015, the company expects to repurchase $1.3 billion worth of stock, which is 5% of the market cap. The board of directors this past month increased the authorization for the amount that the company can repurchase, up to 56 million shares, or over 12% of the existing number of shares outstanding. Repurchasing the shares is one way to accelerate dividend growth, because reducing the share count allows the company to continue to pay out more and more per share. With shares so cheap, the company gets a good rate of return on their purchases, although I’d like to see a moderately higher dividend payout ratio, personally.

Given historical dividend growth rates, recent growth rates, share repurchase rates, core company performance, and an assumption of reducing currency problems over the next 5 years, I’ll use 7% dividend growth as an estimate for the long term. The estimated fair value ends up being around $55:


As you can see, with the fairly low yield, the estimated fair value is very sensitive to adjustments in the estimated dividend growth rate and the discount rate. Overall, with a low P/E, a long history of dividend growth, a modest current dividend yield, and a fairly safe business, I believe Aflac represents a decent purchase at these prices levels, especially with many other stocks being valued at much higher earnings multiples.

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