It is entirely possible that Aflac (NYSE:AFL) is one of the more underrated stocks in the dividend growth universe. It is a company that reliably grows earnings per share, generally increases book value per share, and grows its dividend every year. Its total performance over just about any measurable long-term time frame is nothing short of incredible. For instance, if you put aside $20,000 into Aflac stock in June 1986, you could have just shy of $1,000,000 today, assuming optimal tax strategy. You only need one of those in your life to put together a nice investing career for yourself.
Despite Aflac's long-term record of growing, growing, and (did I mention?) growing, there is a substantial mismatch between the company's current valuation and where it was before the financial crisis hit.
First, let's look at book value. From 2000 to 2007, the company traded between 236% and 298% of book value. Aflac's book value is a little above $34 per share. At the current price of $58 per share, Aflac is trading at 170% of book value. Interestingly enough, Aflac had a higher book value valuation during the financial crisis in 2009, in which the company traded at 191% of book value (and you should keep in mind that this was not due to a collapse in Aflac's book value per share, as Aflac's book value went from $18.08 in 2007 to $17.96 in 2009, which is impressive given the general deterioration of book value among its financial peers).
If Aflac were to trade at the low end of its book value range from 2000 to 2007, the price of the stock would increase from $58 per share to $80.24 per share. If it were to match its 2007 multiple of 295% of book value, the price of the stock would increase to $101.32.
The company is also cheap on a P/E basis if you compare its current valuation multiple to where it was before the financial crisis hit. From 2000 to 2007, Aflac traded between 16x earnings and 21x earnings. Right now, the company is pumping out about $6.33 per share, for a P/E ratio of 9.15x earnings or so. If the P/E ratio reverts towards 16 again, the price of Aflac would head towards $101 per share. And if it reverts to its pre-crisis high P/E ratio that it held for much of the 2001 calendar year, the stock would climb to $132 per share.
Most importantly, Aflac is expected to grow earnings per share by 9.5% and dividends per share by 9.0% through the next four years. That gives Aflac shareholders the potential for substantial capital gains over the medium term if management can grow earnings by a high single digit rate while, simultaneously, market participants adjust to valuing the security more in line with historical norms.
What I like about Aflac right now is the fact that there are a lot of different opportunities for shareholders to do well over the next five years:
1. The first opportunity is earnings growth. First of all, Aflac generates about 80% of its profits in Japan (the specific figure fluctuates around this mark in a given year). The relative weakness of the yen has caused Aflac's earnings to be understated. That gives Aflac's earnings a coiled-spring element to it, as earnings per share figures could catch a nice tailwind if the yen strengthens against the dollar in the next three to five years. Aflac management expects overall earnings to grow by 6-7% on a currency neutral basis this year, and since the company intends to repurchase almost half a billion dollar's worth of stock this year, the gains in earnings per share could realistically approach 10%.
2. Aflac shareholders also stand to benefit from an increase in general valuation. The interesting thing about Aflac's historically low valuation, both on a book value and P/E basis, is the fact that the insurer has just finished executing its "derisking program." Aflac has reduced the European exposure of its investments by 50%, and around 96% of the portfolio is investment grade. The quality of Aflac's earnings are higher than they were in 2007, yet the valuation multiple is much lower. Therein appears the opportunity for mean reversion from a valuation standpoint.
If Aflac is rationally valued five years from now, I would be surprised if investors that bought at $58 per share did not experience total returns of at least 8% annually between now and then. The portfolio quality has improved. The company only has locked in its debt at low rates, and only carries about $200-$300 million worth of long-term interest on its books. The earnings per share should benefit from organic growth, a potentially stronger yen on a long-term basis, and Aflac's current share buyback program. And on a valuation basis, Aflac is currently well below where it has been before the crisis. At the very least, Aflac should be fertile ground for you to perform full due diligence.