Horace Mann Has Been Increasing Dividends Over the Last Seven Years

In this article, let's take a look at Horace Mann Educators Corp. (HMN, Financial), a $1.37 billion market cap company, which operates as a multiline insurance company.

Impressive History

The firm has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends. It has an impressive history of raising dividends as it generates healthy cash flow on a regular basis.

The insurer has been increasing its quarterly dividends consistently over the last seven years. Recently, it has announced a 9% increase in its quarterly dividend to 25 cents from 23 cents per share, which will generate an annualized dividend of $1.0 per share. With a closing price of $33.45 this make an annualized dividend yield of 3.0%.

This move was due to strong results registered previously. "Including fourth quarter operating income of $0.68 per diluted share, Horace Mann's full year operating income was $2.30 per diluted share, reflecting another year of strong performance across all three segments of our multiline insurance platform. Sales in the fourth quarter were strong, with double-digit increases in all three of our segments," said Horace Mann's President and CEO Marita Zuraitis.

Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.

This formula condenses to: V0=(D0 (1+g))/(r-g)=D1/(r-g)

where:

V0 = fundamental value

D0 = last year dividends per share of Exxon's common stock

r = required rate of return on the common stock

g = dividend growth rate

Let´s estimate the inputs for modeling:

Required Rate of Return (r)

The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium

Assumptions:

Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%. This is a very low rate because of today´s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. So I think it is more appropriate to use this rate.

Beta: β =1.32

GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]

rHMN = RF + βHMN [GGM ERP]

= 4.9% + 1.32 [11.43%]

= 19.99%

Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.

g = b x ROE

b = retention rate

ROE=(Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

The “PRAT” Model:

g= ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

Let´s collect the information we need to get the dividend growth rate:

Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.

Dividend growth rate (g) implied by Gordon growth model (long-run rate)

With the GGM formula and simple math:

g = (P0.r - D0)/(P0+D0)

= ($33.45 ×19.99% – $1) ÷ ($33.45 + $1) = 16.5%.

The growth rates are:

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Calculation of Intrinsic Value

Final Comment

We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment.

The market price of a stock tends to follow the intrinsic value, and in this case we found that is trading about 25% more. This should indicate a sell recommendation, but the dividend hike initiative should boost investor confidence and in theory should lead to a stock price appreciation.

Hedge fund guru like Jim Simons (Trades, Portfolio) has taken a long position in the last quarter of 2014. Among investors that had bearish feelings about this stock are Paul Tudor Jones (Trades, Portfolio) who sold the stock; and John Rogers (Trades, Portfolio), Donald Smith (Trades, Portfolio) and David Dreman (Trades, Portfolio) that have reduced their positions in the last quarter of 2014, as well as HOTCHKIS & WILEY

Disclosure: Omar Venerio holds no position in any stocks mentioned.

[1] This values where obtained from Blommberg´s CRP function.