One of my most helpful mental models is the “regret minimization framework”, championed by Jeff Bezos.
It involves mentally projecting yourself out into old age and then working backward from there in order to find out whether or not a particular decision you’re looking at will result in regret.
Commonly, we tend to later regret the things we didn’t do (out of fear), not the things we end up doing.
One huge regret for a lot of people, sometimes based out of fear, is the avoidance of saving and investing when younger.
This can lead to all kinds of negative effects: limited wealth in old age, lack of options, working much longer in life, financial stress, health worries, and even major relationship problems.
It’s why I’m such a proponent of living below your means and employing the dividend growth investing strategy for your savings as early in life as possible.
This is a long-term investment strategy which can set one up for abundance, wealth, and even financial independence by taking one’s savings and directing that toward shares in high-quality businesses paying out reliable, rising cash dividends to shareholders.
You can find hundreds of stocks that fit this description on the Dividend Champions, Contenders, and Challengers list, which has invaluable information on US-listed stocks that have raised dividends each year for at least the last five consecutive years.
These tend to be fabulous long-term investments due to the inherent logic: Being able to consistently grow cash dividend payouts to shareholders is only sustainable when the supportive profit is also consistently growing, and profit that consistently grows is typically something that only great businesses are able to produce.
I’ve been applying the dividend growth investing strategy for the past 15 years, and it’s helped me to build the FIRE Fund.
That’s my real-money portfolio which generates enough five-figure passive dividend income for me to live off of.
In fact, this has been enough to cover me since I quit my job and retired in my early 30s.
My Early Retirement Blueprint goes into detail regarding how I did that and how others can, too (hint: I did a lot of that saving and dividend growth investing I just discussed above).
As effective as dividend growth investing can be, though, what you invest in can be just as important as how you invest in it.
What I mean by that is, valuation at the time of making any investment is a critical consideration.
While price tells you what you pay, value tells you what you get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Living below your means, investing savings into undervalued high-quality dividend growth stocks, and eventually achieving financial independence opens up all kinds of possible life paths and likely mitigates against future regrets.
Of course, all of this makes a lot more sense when one is already familiar with the whole concept of valuation.
If that familiarity is not already in place, be sure to read Lesson 11: Valuation.
Written by fellow contributor Dave Van Knapp, it shares the ins and outs of valuation in an easy-to-understand way and even provides a template you can quickly apply on your own.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Zoetis Inc. (ZTS)
Zoetis Inc. (ZTS) is a US-based company involved in the discovery, development, manufacture, and marketing of animal medicines and vaccines.
Founded in 1952, Zoetis is now a $65 billion (by market cap) animal care giant that employs nearly 14,000 people.
The company reports results across two segments: US, 55% of FY 2024 revenue; International, 45%.
Products for companion animals comprised roughly 70% of last year’s sales, while the remaining sales base was related to livestock or farm animal products.
This is the world’s largest producer of medicine and vaccinations for pets and livestock, manufacturing across 20+ different sites and selling its products across 100+ countries.
In almost every category and geography Zoetis competes in, it’s either #1 or #2.
Zoetis has ~300 product lines and 17 blockbusters (i.e., products with $100 million or more in annual revenue), including Librela and Simparica.
The company’s products cover a broad range of animal health concerns, including inflammation, osteoarthritis, and parasites.
There’s a huge secular growth opportunity at play here, as people are increasingly “humanizing” their pets.
Few of us don’t love animals, and even fewer of us don’t love our pets.
Many of us see pets as members of the family, and their health is now being considered just as much as the health of any other family member.
Putting animal companions on par with humans in terms of health is a massive long-term tailwind for Zoetis, as it leads a huge and growing market with little formidable competition (especially relative to pharmaceutical companies targeting human healthcare).
Simultaneous to the humanization trend, pet ownership is rising across developing countries.
Zoetis itself estimates that its total market will grow to between $60 and $70 billion from a $48 billion base in 2023.
Combining existing dominance with an expanding customer pool is what positions the company for continued strong growth across its revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Regarding that last part, Zoetis has increased its dividend for 13 consecutive years.
This streak is as long as it possibly could be, dating back to the company’s 2013 IPO.
It’s been a dividend grower since the start.
Its 10-year dividend growth rate is 19.6%, which is incredible, and even more recent dividend raises have been in the mid-teens area.
Zoetis has been a dividend growth monster.
Despite that high level of growth, the payout ratio remains at a reasonable 32.2%.
That gives us an early indication that the business itself is growing quickly (otherwise, the payout ratio would already be much higher than this).
The one possible drawback here regarding the dividend is the yield on the stock, which is sitting at 1.4%.
Although that might not entice income-oriented investors, younger dividend growth investors more concerned with the long-term compounding process will probably be able to easily overlook this.
Also, this yield beats the market and is 70 basis points higher than its own five-year average.
Said another way, the stock’s current yield is twice as high as it usually has been.
Hard to ignore that kind of disconnect.
Again, for those who appreciate high-quality compounders, this dividend profile is looking sweet.
Revenue and Earnings Growth
As sweet as it may be, though, this profile is mostly a past-based one.
However, investors must always have a future-based mindset, as today’s capital is ultimately put on the line and risked for tomorrow’s rewards.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will extremely useful for the valuation process.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this way should give us the ability to roughly judge where the business could be going from here.
Zoetis increased its revenue from $4.8 billion in FY 2015 to $9.3 billion in FY 2024.
That’s a compound annual growth rate of 7.6%.
Impressive top-line growth, especially considering the fact that Zoetis is not particularly acquisitive.
High-single-digit revenue growth being so organic is fantastic.
Meanwhile, earnings per share grew from $0.68 to $5.47 over this period, which is a CAGR of 26.1%.
Just incredible.
That’s tech-like bottom-line growth out of animal care.
Circling back around to what I foreshadowed earlier, we can now see that all of that high-teens dividend growth has been clearly supported by even better EPS growth (which is what’s kept a lid on the payout ratio).
A prolific expansion in profitability, as well as buybacks, combined to drive so much of this excess bottom-line growth.
Regarding the latter point, the float has been reduced by nearly 10% over the last decade in a rather steady, methodical cadence.
Looking forward, CFRA is projecting that Zoetis will compound its EPS at an 8% annual rate over the next three years.
This cautiousness assumes a material slowdown in EPS growth, as this would represent a rate of growth that is only about 1/3 of what it’s been over the last decade.
CFRA zooms in on recent weakness in the US livestock side of the business (perhaps owed to rising meat alternatives), which showed a 21% YOY decline in sales in Q2 FY 2025.
However, livestock was basically flat across the non-US markets.
In addition, high-single-digit growth on the companion animal side of the business across both US and International drove overall YOY revenue growth to 4% for the quarter.
I think this is an important point, as US livestock on its own represents a relatively small slice of the overall revenue pie.
What’s happening here is, the largest part of the company’s source of revenue (i.e., spending on companion animal care) is also growing the fastest.
The big will keep getting bigger, and that bodes well.
If I double-click on this, CFRA states: “We expect the core Companion Animal sales growth to remain strong, led by solid demand dynamics and increasing market share for key products. Management seems confident that pet care spending will remain resilient, even in case of economic downturns.”
Indeed, it’s extremely doubtful that pet owners would skip out on taking care of their pet(s) because the economy isn’t humming at 100%.
I’ve seen various studies showing that people are more likely to spend on their dogs than themselves.
This makes Zoetis extremely resilient over time.
There’s also the expanding market, which disproportionately helps a clear leader like Zoetis.
The company’s pipeline should maintain that lead, as CFRA notes: [Zoetis]s’ innovation pipeline continues to progress, in our view, with notable approvals and expanded indications for key products across both the Companion Animal and Livestock segments.”
Indeed, Zoetis has more than 2,000 new products and lifecycle innovations introduced in last 12 years.
I don’t have a serious problem with CFRA’s near-term forecast, but it does look a bit cautious to me.
If we come back around to that most recent Q2 report, EPS came in at 18% higher; FY 2025, through two quarters, is already showing 13% YOY growth.
In my view, it’s more likely that Zoetis will continue to compound its EPS and dividend, respectively, at low-double-digit rates annually (albeit with, perhaps, some modest oscillation along the way).
Although that wouldn’t be quite as spectacular as what transpired over the last decade, that still easily puts the stock on a course for an annual total return of somewhere in the low-teens area (including the dividend) – even without any kind of jump in multiples.
Again, for those who appreciate high-quality compounders, Zoetis appears to be one of the best.
Financial Position
Moving over to the balance sheet, Zoetis has a solid financial position.
The long-term debt/equity ratio is 1.1, while the interest coverage ratio is right about 15.
The former is artificially high, inflated by low common equity (a function of the buybacks).
Also, when including cash, the net long-term debt load of just over $3 billion is fairly immaterial for a company of this size.
Zoetis does command an investment-grade BBB+ long-term credit rating from S&P.
Profitability is outstanding.
Return on equity has averaged 49.5% over the last five years, while net margin has averaged 26.2%.
Very high returns on capital here, which I love to see.
Again, these are tech-like numbers.
To be fair, ROE gets inflated by the balance sheet, but even ROIC is frequently north of 20%.
And to circle back around to the margin expansion story I quickly touched on earlier, net margin was closer to 10% a decade ago.
This is just a better-run firm with more and higher-margin products.
Fundamentally speaking, Zoetis is a wonderful business.
And with economies of scale, R&D, IP, brand name blockbusters, diverse portfolio, barriers to entry, and market leadership, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Regulation, litigation, and competition are omnipresent risks in every industry.
Regulation is of particular importance, as all healthcare/drug companies are heavily scrutinized by regulatory authorities.
Adverse drug events, which could lead to more litigation and regulatory scrutiny, are a constant concern.
R&D must continuously launch new drugs and develop new blockbusters in order to maintain growth and market leadership.
The company’s international footprint exposes it to geopolitics and currency exchange rates.
Rising popularity of meat alternatives weighs on the company’s livestock products.
I don’t see Zoetis as having a very high risk profile.
Yet, with the stock down 40% from its recent all-time high, you’d think the business was in the middle of some kind of crisis…
Valuation
The stock is trading hands for a P/E ratio of 25.2.
While that isn’t exactly low in absolute terms, it’s well below its own five-year average of 37.3.
The cash flow multiple of 21 is also way off of its own five-year average of 30.2.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a two-stage dividend discount model analysis.
I factored in a 10% discount rate, a 10-year dividend growth rate of 14%, and a long-term dividend growth rate of 8%.
The company’s most recent dividend increase came in at nearly 16%, so I’m extrapolating out a slightly lower rate than this into the next decade.
As I showed earlier, Zoetis appears poised for low-double-digit EPS growth over the coming years.
With the payout ratio being as low as it is, some excess dividend growth (via payout ratio expansion) is easily attainable.
From there, I’d assume high-single-digit dividend growth out over a longer period of time, which is in line with most assumptions I make for high-quality companies like Zoetis.
There is nothing herculean being expected here.
Just business as usual.
The DDM analysis gives me a fair value of $178.83.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
The stock appears to be materially undervalued to my eye.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates ZTS as a 4-star stock, with a fair value estimate of $171.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates ZTS as a 4-star “BUY”, with a 12-month target price of $185.00.
We have a fairly tight consensus. Averaging the three numbers out gives us a final valuation of $178.28, which would indicate the stock is possibly 19% undervalued.
Bottom line: Zoetis Inc. (ZTS) is a high-quality, industry-leading company positioned to benefit from the rising trend of companion animal “humanization”. The bond between people and their pets is extremely strong, and animal care is almost immune to economic factors. With a market-beating yield, double-digit dividend growth, a low payout ratio, more than 10 consecutive years of dividend increases, and the potential that shares are 19% undervalued, this is a terrific high-quality compounder for patient long-term dividend growth investors.
-Jason Fieber
Note from D&I: How safe is ZTS‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 74. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, ZTS‘s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Disclosure: I’m long ZTS.
