Altria: This Dividend Stock Is Undervalued Using The Dividend Discount Model

Investors should consider valuation before buying stocks. Even a high-quality business can amount to a poor investment if too high a price is paid for the shares. Buying overvalued stocks is a recipe for weak returns over the long run.

By contrast, buying undervalued stocks with growth potential and high dividend yields is a proven method of generating strong returns over time. One popular valuation method is known as the Dividend Discount Model or DDM.

According to the DDM, shares of high-yield dividend stock Altria Group (MO) are significantly undervalued today.

Business Overview

Altria Group is a giant in the tobacco industry. Its flagship Marlboro cigarette brand accounts for over 40% of domestic retail market share. Altria also has non-smokable brands Skoal and Copenhagen chewing tobacco, Ste. Michelle wine, and owns a 10% investment stake in global beer giant Anheuser Busch InBev (BUD).

Altria reported solid financial results for the past year. Fourth-quarter revenue net of excise taxes increased 1.5% to $4.8 billion, thanks largely to price increases. Adjusted earnings-per-share of $0.95 increased 4.4% from the same quarter a year ago. The company managed its earnings growth primarily due to revenue growth, share repurchases, and a lower tax rate.  

A major goal of value investing is to buy stocks that are undervalued. In other words, the investor wants to buy stocks when the market has not adequately priced in the company’s future growth. Altria is investing heavily in growth, particularly by investing in adjacent product categories. Altria recently announced a $1.8 billion investment in Canadian marijuana producer Cronos Group. Altria purchased a 45% equity stake in Cronos. Separately, Altria invested nearly $13 billion in e-vapor manufacturer JUUL Labs for a 35% equity stake in the company, valuing JUUL at $38 billion.

These investments will help Altria prepare for the future. In the meantime, Altria generates huge cash flow, thanks to its competitive advantages. Altria’s core product Marlboro commands brand loyalty and the ability to raise prices each year. Altria is also highly resistant to recessions. Cigarette and alcohol sales fare very well during recessions, which keeps Altria’s strong dividend growth intact each year.

Valuation Analysis

The Dividend Discount Model, or DDM, estimates the fair value of a stock based on its dividend payout and future dividend growth, discounted to the present. According to the Dividend Discount Model, the fair value of a stock is equal to next year’s expected dividend divided by an appropriate discount rate, less the expected dividend growth rate.

The discount rate is determined by the Capital Asset Pricing Model, or CAPM, in which the discount rate is equal to the stock’s beta value multiplied by the sum of the market risk premium and the risk-free rate. The current market risk premium is 5.8%, calculated by the long-term inflation-adjusted return of the market (2.2%), plus the S&P 500 Index current dividend yield (1.9%), and the expected future inflation rate of 1.7%.

We can now apply the Dividend Discount Model. For Altria, the forward 1-year dividend payout is expected to be $3.37 per share. Therefore, the appropriate discount rate is 4.7%, using a risk-free rate of 2.4%, beta value of 0.54, and a market risk premium of 5.8%. If investors assume a 1% annual dividend growth rate, Altria shares are worth approximately $75 per share according to the Dividend Discount Model. Currently priced at $55 per share, it appears Altria stock is significantly undervalued using the DDM.

 

Disclaimer: Sure Dividend is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities. However, the publishers of Sure ...

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Craig Richards 5 years ago Member's comment

I like $MO.