A Moderate-Risk, High-Reward Dividend Play

| About: Aflac Incorporated (AFL)

During the second half of the 20th century, there was a small handful of blue-chip stocks that served as a "secret handshake" of sorts among those steeped in dividend investing. While most of us are aware that companies such as Coca-Cola (NYSE:KO) and Johnson & Johnson (NYSE:JNJ) have been great friends to those that enjoy rising income streams over time, but there has been a small collection of other blue-chip stocks that have had a great run during the second half of the 20th century into the 2000s that may be less apparent to the lay investor.

One of them was the Abbott Labs (NYSE:ABT) before the spinoff. With that company, dividend investors had been getting dividend raises of about 10% for half a century. Another one is Becton Dickinson (NYSE:BDX). With only a slight aberration or two, the mid-cap health company has been growing the dividend by 13% since the early 1960s.

And then there is another dividend growth company that has been one of those "investments that can change your entire life" over the past 40 years: Aflac Insurance (NYSE:AFL). The dividend growth credentials for this company are much better than what you might initially guess (or at least, I was surprised by the results when reviewing the company's history).

-Aflac has been raising its dividend for three decades

-The company has a compound annual growth rate of almost 17% since 1983.

-From a total return perspective, the company has compounded at 19.88% over the past three decades. If you had invested $10,000 into Aflac 30 years ago, you would have just a smidge under $2,000,000 today. Assuming optimal tax strategy, you would be generating $50,900 in annual Aflac dividends today. You'd be getting 509% of your initial $10,000 investment (in nominal dollars) returned to you each year in dividends.

The one "catch," if you will, with holding Aflac stock is that the price occasionally collapses dramatically. We saw that five years ago when the price fell from $68 in 2008, to $10.80 in 2009. Not everyone can handle seeing peak-to-trough action of 80% with a particular holding.

However, if you can think like a long-term business owner and ignore volatility, you can ride these storms out.

The interesting thing about Aflac's business performance from 2008 to 2009 is that earnings per share grew from $2.62 to $3.91, dividends grew from $0.96 per share to $1.12 per share, investment income per share grew from $5.52 to $5.90 per share, and Aflac's book value per share grew from $14.23 to $17.96. As the share price was plunging from the $60s to the $10s, the company was actually improving operational results, which manifested themselves in yet another dividend increase for shareholders despite the stock price volatility.

As far as 80% declines go, the Aflac one wasn't too bad. This wasn't exactly Anaconda Copper falling 80% during the 1927-1933 period as earnings fell 70%. Aflac was a company growing profits and distributions to shareholders as the stock price plummeted. The Anaconda investors of yesteryear had to make a difficult judgment call about long-term earnings power by determining whether the earnings collapse was fleeting or permanent. The Aflac investor was seeing the company improve as share price collapsed.

What is interesting about Aflac right now is that the current figures for the company might be a bit understated. When you pull up a stock screen and see that Aflac is trading at $55.84 relative to $6.33 in earnings, you may think that the stock is cheap at 8.78x earnings. Before 2009, you would have to go back a generation (to the early 1990s) to find a period when Aflac traded with a P/E ratio below 16 for an entire year (book value can be a difficult metric to base Aflac purchase decisions upon because Aflac's average price in relation to book value has fluctuated wildly in a range of 136% to book all the way up to 404%).

Yes, Aflac looks cheap on a P/E metric. But in my opinion, it is even cheaper than that because of the fact that most of its business is in Japan, meaning that Aflac generates its profits in yen, which has done poorly relative to the dollar lately. At the end of 2012, Aflac was generating 80% of its profits and 78% of its revenues in the yen. Because of the yen's weakness, the operating income that you see from Aflac is likely understated a bit due to currency weakness. Because I'd rather show than tell, check out this report from Businessweek that fairly summarizes my thoughts on this matter:

The company does a significant portion of its business in Japan, so a weaker yen means that value of its revenue translates into fewer dollars. The Japanese yen plunged against the U.S. dollar in the last four months amid speculation that Japanese Prime Minister Shinzo Abe will push for more aggressive stimulus measures.

Aflac said that total revenues at its Japan unit rose 10.5 percent in the fourth quarter as premium income and net-investment income rose. That gain in revenue was offset by a 4.4 percent decline in the average exchange rate for the yen versus the dollar in the fourth quarter.

Aflac has seen a lot of these 7-9% growths in operating quarters that have not been fully realized in reported dollars due to the weak yen. When that currency situation stabilizes (or if the yen has a couple years of strength in relation to the dollar), Aflac shareholders should catch a nice little tailwind.

Another thing that may be underappreciated is that the quality of Aflac's earnings growth has been improving. In the past two years, Aflac has divested about 10 percentage points worth of its investment exposure to countries classified as "troubled Europe." Almost 96% of its investment portfolio is now considered investment grade. When you read of 7-9% operational growth (before currency translations), you can take some solace in the fact that this type of growth is being achieved in a lower risk way than it was during the financial crisis.

Aflac may be an ideal "branch out" stock for a conservative blue-chip dividend investor. Once you get the Exxons (NYSE:XOM) and Johnson & Johnsons planted firmly in your portfolio, it could be worthwhile to look at Aflac as a possible high-return opportunity. The earnings have gone up by 14% and the dividend has gone up by 20% over the past decade, the company is trading at a cheap P/E ratio despite higher earnings quality, and the operational results that you see today may be understated by the weak performance of the yen. When you mix those facts together with analyst expectations that Aflac will grow earnings and dividends by 9% annually over the medium term, this accident and health insurer company may be fertile ground for further due diligence.

Disclosure: I am long BDX, XOM, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.