A Dividend Yield, Dividend Safety and Valuation Trifecta

When considering a dividend stock, investors are usually looking for a variety of attributes. Three of the most important things to look for in a high-quality dividend stock are a high yield, dividend safety with a low payout ratio, and a low stock valuation. High dividend yields are naturally appealing for income investors. Of course, high dividend stocks are only attractive if the payout ratio is low enough so that the dividend is sustainable, or better yet grows over time. In that same vein, a reasonable valuation is also important, as even the best dividend growth stock can generate poor returns if it is overvalued at the time of purchase. It's rare to find all three major attributes at once, but that's exactly what Prudential Financial is presently offering. Business Overview Prudential Financial, now in business for over 140 years, operates in the United States, Asia, Europe and Latin America, with $1.7 trillion in assets under management (AUM). The company provides financial products, including life insurance, annuities, retirement-related services, mutual funds and investment management. Prudential operates in four divisions: PGIM (formerly Prudential Investment Management), U.S. Workplace Solutions, U.S. Individual Solutions, and International Insurance. On Feb. 4, Prudential released fourth-quarter and full-year 2020 results. For the quarter, Prudential reported net income of $819 million or $2.03 per share, compared with $1.128 billion or $2.76 in the same quarter the previous year. However, on an adjusted basis, Prudential grew adjusted EPS by 31% for the quarter, to $2.93 per share. For the year, Prudential reported a net loss of $374 million or $1.00 per share versus a gain of $4.186 billion or $10.11 per share in 2019. However, this included significant investment losses. After-tax adjusted operating income equaled $4.111 billion or $10.21 per share, compared to $4.656 billion or $11.24 per share in 2019. At quarter-end Prudential held $1.721 trillion in AUM versus $1.551 trillion in the year-ago period. Prudential's adjusted book value per share equaled $94.79, down from $101.04 in 2019. Prudential also authorized $1.5 billion in share repurchases for 2021 and declared a $1.15 quarterly dividend, a 4.5% year-over-year increase. Growth Prospects If you start in 2007 (when the company was earning $7.31 per share and paying out $1.15) through 2019, Prudential grew EPS by about 4.0% per year. However, 2020 proved to be a down year, with earnings down 13%, amid difficult circumstances. Higher interest rates and general economic improvement could be positives for the company's growth prospects over the long-term. Of course, there are offsetting factors, chief among them being lower rather than higher rates in the short-term. The majority of Prudential's business is in the U.S. and Japan, both of which are mature markets where we do not anticipate above-average growth. Life insurance and annuities are highly competitive industries. Further, insurers do not know the price of the goods sold for years, allowing for the temptation to underprice policies in search for growth. We believe a slow, steady and profitable approach in this industry is prudent. We are expecting earnings to bounce back in 2021, forecasting $11.50 in EPS -- to go along with a 4% expected EPS growth over the next five years. This implies the potential for $14.00 in EPS after five years. Of course, the timing and magnitude of a recovery from the COVID-19 pandemic will continue to be an unknown in the short-term. Prudential has fared relatively well over the past year, as it has maintained its hefty dividend. Dividend Safety Prudential has now paid and increased its dividend for 13 consecutive years. The dividend remains very well covered, as it has been for the past decade. In fact, the company's dividend payout ratio never exceeded 50% in the past decade, including 2020 which was a very difficult year for the global economy. This has allowed the company to raise its dividend for several years. Since 2011 Prudential has grown EPS by an average compound rate of 5.3% per year, while the dividend has increased by a 13.1% annualized rate. This is why the payout ratio has gone from 23% to 43% in the last decade. Moving forward you might anticipate dividend growth to more closely track earnings growth -- you can only outpace bottom line results for so long. However, it's clear that the payout ratio leaves ample room for future payout increases. Valuation/Expected Return Based on a current share price near $81.50, a $1.15 quarterly dividend and $11.50 in expected EPS this year, Prudential is presently trading hands with a 5.6% dividend yield, 7.1 P/E ratio and ~40% payout ratio. If earnings were to grow by 4% annually, investors could expect Prudential to earn $14 per share or thereabouts after five years. Over the past decade shares have traded hands with an average P/E ratio of 8 to 9 times earnings. Using 8 times earnings, this implies the potential for a future share price of ~$112. If the dividend were to also grow by 4% per year, this would imply a $5.60 annual dividend in the next half decade. Investors could anticipate receiving ~$26 or so in cash payments in the coming five years. Adding together the potential share price and dividends you come to a collective value of ~$138, keeping in mind that this is merely one possibility out of many. Against the current share price of $81.50, this works out to the possibility for 11.1% annual returns in the coming five years. Final Thoughts Prudential is a unique dividend security in that it offers a 5.6% starting dividend, a 7.1 P/E ratio and a 40% payout ratio -- a trifecta of positive attributes. The company has a long history of growing its earnings. Moreover, the shares could now be offering the opportunity for double-digit intermediate-term gains. Prudential's well-covered and above-average dividend yield appears compelling for value and income investors.

A Dividend Yield, Dividend Safety and Valuation Trifecta

It's rare to find all three major attributes at once, but this insurer has them.

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