A dividend is just one of many ways a company can reward its shareholders by paying them out in cash. The investor can then choose to take the cash and run, reinvest it in the company, or invest it in a different company. After a company has made their net income for the quarter they have the choice of what to do with it and the choices are usually to either plow the money back into the business for other investments or pay some of that money back to the shareholders in the form of a dividend.
Most Recent Dividend Announcement
Eaton Vance Corp (NYSE:EV) recently announced a quarterly dividend of $0.265 per share with an ex-dividend which was on April 27th, making the must own date April 26 th. The dividend is going to be payable to owners of the shares on May 13th. The dividend is currently good for a 2.99% yield on today's share price of $35.44. Based on trailing earnings, the dividend is good for a payout ratio of 51% which is pretty good for my taste. From a cash flow perspective the company has paid $117 million in dividends over the past twelve months on free cash flow of $361 million which is good for a 32% cash flow payout ratio.
Potential Future Dividends
The company has been increasing its dividend for the past 35 years with a five-year dividend growth rate of 9%. Over the past five years the company has been increasing its dividend during the month of October and it wouldn't surprise me if it did the same thing in 2016.
The company is projected to earn $2.36 per share in earnings for next year and if the EPS payout ratio remains the same at 51% then the company should distribute about $1.20 annually starting October (or a 13% increase). That amount seems pretty reasonable and I do believe the 51% payout ratio is sustainable for the long-term.
Earnings growth projections for the company are pretty decent for an asset management company with a one year growth rate of 14.3% and five year growth rate of 4.5%. With that said, a 4.5% increase to the dividend would be much more prudent than 13%. A 4.5% increase would constitute an annual dividend of$1.10 for 2016 if it increases the dividend in October.
Now let's get to the meat and potatoes, the dividend valuation model to determine a price that the stock should be at based on the dividend alone. Since I just mentioned that the company has been increasing its dividend for the past 35 years we know that it has a pretty good history of increasing it and should continue to increase it going into the future. The dividend growth model equation takes the form of:
Annual Dividend [D]
Rate of Return [R] - Dividend Growth rate [G]
Where D is equivalent to the current dividend, R is the rate of return desired by the investor, and G is the anticipated growth rate of the dividend. For the D value I'm going to use the existing dividend rate of $1.06.
For the R value I'm going to use 7.1% because it is half of what next year's earnings estimates are expected to be. For the G value of the equation I'm going to use a dividend growth rate of 4.5% because I definitely believe the company could increase the dividend by that much at least for the next year to keep investors happy. When you plug and chug all the numbers you get a stock value of $42.40 which makes the stock undervalued by about 19% from today's price of $35.57. For reference, the 52-week high on the stock was$43.69 around this time last year.
The dividend discount model is just one of many ways to value a company and should be taken into consideration while trying to evaluate a company. Assumptions are always made while using valuation models and I believe I've selected some of the most conservative criteria for the valuation in this article. This valuation model shows the value of the dividend stream and that the stock is undervalued based on the dividend alone. The company has been around for quite some time and can definitely afford to increase the dividend when October 2016 comes around.
The stock will definitely go higher in the near-term due to the market volatility mainly because people have been bidding up the financial companies after JPMorgan (NYSE:JPM) beat first quarter earnings estimates.
The stock has shot up since early February and the company currently trades at a trailing 12-month P/E ratio of 15.57, which is fairly priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 14.51 is currently inexpensively priced for the future in terms of the right here, right now. Next year's estimated earnings are $2.36 per share and I'd consider the stock inexpensive until about $35. The 1-year PEG ratio (1.09), which measures the ratio of the price you're currently paying for the trailing 12-month earnings on the stock while dividing it by the earnings growth of the company for a specified amount of time (I like looking at a 1-year horizon), tells me that the company is fairly priced based on a 1-year EPS growth rate of 14.25%. The company has great near-term future earnings growth potential with a projected EPS growth rate of 14.25%.
I actually initiated my position in the company in late December and have been pretty happy with the purchase thus far. But I never look to initiate a full position in a name immediately and think the stock is a buy as long as it is below $35 (which is the midway point of the 52-week range). I never like to dive full bore into a name, I always buy in increments.
I swapped out of 3M (NYSE: MMM) for Eaton Vance during the portfolio change-out in the fourth quarter of 2015 because I had a good gain in 3M ( 13.4%) and felt that it might lag the rest of the market for the coming three months.
For now, the chart above compares how 3M and Eaton Vance have done against each other and the S&P 500 since I swapped the names. It doesn't look like the trade has worked out from the chart and that is because Eaton Vance dropped right after earnings on November 24 and has struggled since then. However, I am actually up 20% on the name because I have been lining the bottom with constant purchases. For now I'm going to stop making purchases in the name because I have a great gain and don't want to increase my cost average.
Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing!
Disclosure: I am/we are long EV.
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.