America offers almost unlimited opportunities to regular people.
It’s really the only country in the world where that is possible.
And, perhaps, the best way to tap into that potential is via the US stock market.
The US stock market is the largest and most robust in the whole world.
It’s been one of the world’s greatest wealth generators over the last century, and it’s accessible to everyone.
If one is going to access the US stock market, I think the most effective way to do so is by employing the dividend growth investing strategy.
This is a long-term investment strategy that encourages buying and holding shares in high-quality businesses rewarding shareholders with steadily rising cash dividend payments.
Those steadily rising cash dividend payments are, of course, funded by steadily rising profits, and steadily rising profits only come about when businesses are terrific and being run well.
You simply cannot have a poor business, run it into the ground, and also be able to afford generous, rising cash dividend payouts.
That equation breaks quickly.
If you pull up the Dividend Champions, Contenders, and Challengers list, you’ll see hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
It’s a treasure trove of data for the dividend growth investing strategy.
By the way, I’ve been using this strategy for the last 15 years.
It’s guided me as I’ve gone about building the FIRE Fund.
That’s my real-money portfolio, and it generates enough five-figure passive dividend income for me to live off of.
This passive dividend income has been enough for me to live off of since I quit my job and retired in my early 30s, which is something detailed in my Early Retirement Blueprint.
Now, the dividend growth investing strategy involves not just investing in the right businesses but also investing at the right valuations.
The reason for that is this: Price is what you pay, but value is 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.
Tapping into the immense power of the US stock market by buying undervalued high-quality dividend growth stocks can allow regular people to build significant wealth and passive income, and even become financially independent over time – something almost unheard of in almost every other area of the world.
Now, taking advantage of undervaluation does require one to first understand the ins and outs of the whole concept of valuation.
Well, that’s where Lesson 11: Valuation comes in.
Written by fellow contributor Dave Van Knapp, it deftly explains valuation using simple terminology and gives everyday investors the tools to confidently judge values on their 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…
FactSet Research Systems Inc. (FDS)
FactSet Research Systems Inc. (FDS) is an American financial data and software company.
Founded in 1978, FactSet is now a $14 billion (by market cap) financial data provider that employs more than 12,000 people.
The company breaks down revenue by geography: Americas, 64% of FY 2024 revenue; EMEA, 26%; and Asia-Pacific, 10%.
FactSet has nearly 220,000 users, with most of its clients being institutional buy side (i.e., institutional asset management).
The company has a very diversified customer base, with its largest client accounting for approximately 3% of annual revenue.
FactSet runs a terrific business model: It’s an asset-light provider of high-value financial data, software, and analytics via subscriptions to well-heeled customers (such as asset managers, bankers, wealth managers, hedge funds, and private equity firms) who demand this information and are able and willing to pay for it.
Seeing as how FactSet’s full product costs ~$12,000/year, having both the ability and willingness to pay is critical.
While that might seem like a lot of money to a retail investor, $1,000 per month is trivial for institutional asset managers with billions of dollars under management.
These institutional players are under the gun when it comes to performance, and they need as much data as possible (and they need it quickly) in order to make informed decisions.
Furthermore, what FactSet charges actually pales in comparison to the ~$30,000 per year a Bloomberg Terminal subscription can run (i.e., more than twice as much as what FactSet charges).
This gives FactSet a major cost advantage over key rivals.
For what it charges, FactSet provides both proprietary and third-party data, including estimates, news, and historical information.
It also offers valuable, customized solutions such as investment research, portfolio analysis, performance evaluation, and risk management assessment.
Clients require these solutions, and the subscriptions lock them in.
Being among a group of companies underpinning the $100+ trillion global capital markets, FactSet has a very lucrative “seat at the table”, able to feed off of massive and rising global wealth through high-margin, recurring, sticky subscription revenue.
This is why FactSet has been able to post up (and should continue to post up) high rates of growth across its revenue, profit, and dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
To date, FactSet has increased its dividend for 27 consecutive years.
That qualifies it for its status as a vaunted Dividend Aristocrat, reinforcing just how consistent and reliable this business has been for decades.
The 10-year dividend growth rate of 10.4% is quite solid, although the last few dividend raises have been lower than trend.
Paired with that double-digit dividend growth is the stock’s yield of 1.2%.
That probably won’t entice income investors, but it’s a pretty respectable yield for a high-quality compounder.
It should also be noted that this yield is 30 basis points higher than its own five-year average, so new investors getting in now are gaining a higher yield than usual for this name.
And with the payout ratio sitting at just 31.8%, I suspect FactSet has many, many more years of high rates of dividend growth still ahead of it.
As long as one is not in need of immediate income, this stock has great dividend marks that befit its Dividend Aristocracy.
Revenue and Earnings Growth
As great as they may be, though, these marks are based on what’s already happened in the past.
However, investors must always be thinking about the future, as the capital of today gets put on the line and risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will be highly useful when the time comes later to estimate fair value.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
And I’ll then reveal a professional prognostication for near-term profit growth.
Lining up the proven past with a future forecast in this manner should give us enough data to sensibly judge where the business could be going from here.
FactSet grew its revenue from $1 billion in FY 2015 to $2.2 billion in FY 2024.
That’s a compound annual growth rate of 9.2%.
Strong top-line growth here, but it’s not totally organic.
Revenue was given a boost starting in 2022 by the ~$2 billion acquisition of CUSIP Global Services, a proprietary database of data elements uniquely identifying more than 50 million global financial instruments, from S&P Global Inc. (SPGI).
While the acquisition, which strengthened FactSet’s stranglehold on valuable financial data, resulted in a nice bump in revenue (CGS was doing nearly $200 million in annual revenue), FactSet had already been consistently doing high-single-digit top-line growth.
In fact, FactSet hasn’t had a year-over year decline in revenue over the last 40+ years.
It’s quite remarkable.
Meanwhile, earnings per share increased from $5.71 to $13.91 over this period, which is a CAGR of 10.4%.
You can see how EPS and dividend growth over the last decade line up perfectly with one another.
This company just doesn’t miss a beat.
It’s a well-oiled machine.
Looking forward, CFRA has a forecast for FactSet to grow its EPS at a CAGR of 9% over the next three years.
This lines up fairly closely with what FactSet put together over the last decade.
Supporting an enthusiastic long-term outlook for the business, CFRA drops this nugget: “The company’s stability is evidenced by 44 years of revenue growth and 28 years of earnings growth.”
I mean, that says it all.
I don’t have an issue with CFRA’s number.
It aligns well with FactSet’s own near-term guidance, which calls for 8.6% YOY EPS growth for FY 2025 (using midpoint guidance).
Like I mentioned earlier, FactSet had long been producing high-single-digit EPS growth prior to its CGS acquisition, and I see a slight improvement in that growth profile out of a post-acquisition FactSet.
Framing that view in a bit, CGS has been expanding CUSIP coverage for venture-backed and private equity-owned companies, giving FactSet a new universe of coverage and valuable cataloging.
This acquisition also de-risked the business model some, as the financial data the company has historically trafficked in is at risk of demand destruction in the future from the secular move toward passive asset management.
If we take that 9% number as our base case, that opens up FactSet for low-double-digit dividend growth over the medium term; the low payout ratio has room for expansion and can easily support dividend growth slightly in excess of EPS growth for a decade or more.
Basically, it appears to be more of the same out of one of the most consistent and reliable financial firms out there.
Seeing as how the stock has been compounding at a low-double-digit rate (including reinvested dividends), more of the same would be a great outcome.
Again, it’s not a prime candidate for income-seeking investors, but younger investors who appreciate high-quality compounders should recognize an appealing pattern right about now.
Financial Position
Moving over to the balance sheet, FactSet has a good financial position.
The long-term debt/equity ratio is 0.6, while the interest coverage ratio is over 10.
These numbers don’t “wow” me, but I think it’s important to put them in context.
First, FactSet has, over most of its history, had a fortress balance sheet, but the company took on quite a bit of debt to finance the CGS acquisition.
After peaking in 2022 (the year of the acquisition), long-term debt has been steadily reduced and is now 20% lower than it was then.
Also, after accounting for cash, net long-term debt of ~$750 million is not cumbersome for a company of this size.
As debt continues to drop, the balance sheet will improve off of what is already a good spot and get back to its prior stellar glory.
Profitability is outstanding.
Return on equity has averaged 37.1% over the last five years, while net margin has averaged 23.7%.
FactSet is generating very high returns on capital and fat margins, which I love to see.
And I see the CGS side of the house as reinforcing its ability to maintain that level of profitability.
It’s hard to overstate the impressiveness of this business, especially as it pertains to its world-class consistency.
And with economies of scale, a subscription-based service that’s “sticky”, switching costs, brand recognition, and IP, 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.
Competition, in particular, is a major risk, as FactSet has a small share of a market (estimated at 4%) that is fiercely competitive with locked-in customers on other platforms.
While the company’s core subscription is cheaper than the main competition, these very high prices throughout the industry, in general, could be subject to deflation and disruption over time.
Adding to that last point, AI could make data easier to access and more commoditized, leading to severe drops in demand and pricing for subscriptions.
The company is exposed to the health of and interest in capital markets, and any deterioration across markets that harm the financial health of clients would likely negatively impact FactSet.
This capital markets exposure also exposes the company to broader macroeconomic trends and the overall health of the global economy.
FactSet’s international footprint involves foreign markets and fluctuating currency exchange rates.
A secular trend within the financial industry of assets moving from active to passive management could eventually lead to deteriorating demand for the kind of information that FactSet provides, although this trend, which has been playing out for years already, hasn’t yet had a noticeable negative impact on the business.
I do see some risks here, but FactSet’s quality and consistency are overwhelmingly positive.
And with the stock down more than 25% from recent highs, the valuation compression has led to a much more attractive entry point…
Valuation
The stock is now trading hands for a P/E ratio of 26.2.
In absolute terms, that’s not low.
However, in comparison to the stock’s own five-year average P/E ratio of 35.1, it is low.
The market has typically allowed this stock to command an extremely healthy premium, which seems somewhat deserved in light of its quality and consistency, but that premium has definitely shrunk in recent months.
The cash flow multiple of 19.2, which isn’t unreasonable, is also well off of its own five-year average of 24.4.
And the yield, as noted earlier, is 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, an 11% dividend growth rate for the next 20 years, and a long-term dividend growth rate of 8%.
This is the same model I used the last time I looked at FactSet, and I’m comfortable with using it once again.
I’m essentially extrapolating out the 10-year dividend growth rate well into the future, and I’m then assuming an eventual slowdown into a high-single-digit type of growth rate.
Based on FactSet’s ability to consistently do this kind of dividend growth for decades, I don’t think I’m stretching too much.
It’s long been one of the most dependable names out there, able to churn out magic every single year.
Nothing I see indicates any kind of radical change, and so the status quo seems like the most likely outcome from here.
The DDM analysis gives me a fair value of $381.65.
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.
In my view, this stock’s recent correction has led to it swinging from too expensive to decently cheap.
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 FDS as a 3-star stock, with a fair value estimate of $415.00.
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 FDS as a 4-star “BUY”, with a 12-month target price of $540.00.
I landed low on this one. Averaging the three numbers out gives us a final valuation of $445.55, which would indicate the stock is possibly 19% undervalued.
Bottom line: FactSet Research Systems Inc. (FDS) has a terrific business model, backed by proprietary data it offers to well-heeled clients through high-priced, high-value subscription services. It generates extremely consistent growth and very high returns on capital. With a market-like yield, double-digit dividend growth, a low payout ratio, more than 25 consecutive years of dividend increases, and the potential that shares are 19% undervalued, long-term dividend growth investors should consider buying this elite Dividend Aristocrat while it appears to be on sale.
-Jason Fieber
Note from D&I: How safe is FDS‘s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 95. 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, FDS‘s dividend appears Very Safe with a very 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 have no position in FDS.
