In this article, let´s take a look at Assurant Inc. (AIZ, Financial), which has raised its quarterly dividend to $0.5 per share. This way, the stock yields 2.6% if the share price stays at current levels. Further, it authorized the repurchase of up to an additional $750 million of its common stock. The company maintains a solid financial position, and we expect it to use excess capital to repurchase shares and for dividend payments.
Recent news
Sun Life Financial (SLF, Financial) and the company agreed to acquire employee benefits unit in a deal valued at $975 million. The deal will create one of the largest group benefits businesses by revenue in the U.S. as well as adding six Canadian cents to Sun Life's 2016 earnings.
Relative valuation and dividend yield
The company is trading at a P/E ratio of 20.21x and is close to 10-year high of 21x but is a bit expensive than competitors such as First American Financial Corp (FAF, Financial) and Cigna Corp (CI, Financial).
By dividend yield, Altria Group's (MO, Financial) dividend looks attractive but is below Philip Morris (PM, Financial).
| Company | P/E Ratio | Dividend Yield (%) |
| Assurant | 20.21 | 1.48 |
| First American Financial | 14.7 | 2.52 |
| Cigna | 17.47 | 0.03 |
Intrinsic value
The Yahoo! (YHOO, Financial) Finance consensus price target is $81.86, so now let´s try to estimate the fair value of the firm, for that purpose I will use the Dividend Discount Model (DDM). In stock valuation models, DDM define cash flow as the dividends to be received by the shareholders. The model 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).
Once the appropriate model is selected, 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.
Let´s estimate the inputs for modeling:
First, we need to calculate the different discount rates, i.e. the cost of equity (from CAPM). The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stock j = risk-free rate + beta of j x equity risk premium
Risk-Free Rate: Rate of return on LT Government Debt: RF = 3.03%[1]. I think this is a very low rate. Since 1900, yields have ranged from a little less than 2% to 15%, with an average rate of 4.9%. It is more appropriate to use this rate.
Gordon Growth Model 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%[2]
Beta: From Yahoo! Finance we obtain a β = 0.873731
The result given by the CAPM is a cost of equity of: rAIZ = RF + βAIZ [GGM ERP] = 4.9% + 0.873731 [11.43%] = 14.89%
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)
Collecting the financial information for the last three years, each ratio was calculated, and then to have a better approximation I proceeded to find the three-year average:
| Retention rate | 1.04 |
| Profit margin | 0.05 |
| Asset turnover | 0.31 |
| Financial leverage | 5.97 |
Now, is easy to find the g = Retention rate × Profit margin × Asset turnover × Financial leverage = 10.03%
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. In other words, 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)
= ($76.82 × 14.89% – $2.0) ÷ ($76.82 + $2.0) = 11.97%.
The growth rates are:
| Year | Value | g(t) |
| 1 | g(1) | 10.03% |
| 2 | g(2) | 10.51% |
| 3 | g(3) | 11.00% |
| 4 | g(4) | 11.49% |
| 5 | g(5) | 11.97% |
G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).
Now that we have all the inputs, let´s discount the cash flows to find the intrinsic value:
| Year | Value | Cash Flow | Present value |
| 0 | Div 0 | 2.00 | Â |
| 1 | Div 1 | 2.20 | 1.915 |
| 2 | Div 2 | 2.43 | 1.842 |
| 3 | Div 3 | 2.70 | 1.780 |
| 4 | Div 4 | 3.01 | 1.727 |
| 5 | Div 5 | 3.37 | 1.684 |
| 5 | Terminal Value | 129.43 | 64.666 |
| Intrinsic value | Â | Â | 73.61 |
| Current share price | Â | Â | 76.82 |
| Upside Potential | Â | Â | -4% |
Final comment
Intrinsic value is below the trading price by 4%, so according to the model and assumptions, the stock is overvalued. But considering a margin of safety (usually around 20%) we can say that the stock is fairly valued.
However, we must keep in mind that the model is a valuation method, and investors should not rely on one alone in order to determine a fair (over/under) value for a potential investment.
Hedge fund gurus like Jim Simons (Trades, Portfolio), David Dreman (Trades, Portfolio) and Richard Pzena (Trades, Portfolio) have upped their stakes by 29.87%, 26.38% and 9.01%, respectively. Further, RS Investment Management has initiated a new position with 218,620 shares.
Disclosure: As of this writing, Omar Venerio did not hold a position in any of the aforementioned stocks.
[1] This value was obtained from the U.S. Department of the Treasury.
[2] These values were obtained from Bloomberg´s CRP function.
