Concerns over rising inflation, future interest rate hikes, and a potential recession have spooked financial markets. This has caused the S&P 500 index to plunge 14% year-to-date (as of May 5, 2022).
But quality dividend stocks can help investors to focus on their steadily growing passive income rather than fickle paper gains or losses. The anecdotal evidence from my investing career is that this has helped me avoid making poor decisions during market corrections.
One stock that is featured prominently in my portfolio is the Dividend King Leggett & Platt (NYSE:LEG). For the first time since my previous article last September, I'll go over a few reasons why I currently rate the stock a buy and recently added to my position.
A Dividend Raise Is Around The Corner
Leggett & Platt has raised its dividend paid to shareholders for 50 years straight. And it appears as though the stock's market-smashing 4.6% dividend yield is safe.
Leggett & Platt generated $2.78 in adjusted EPS in 2021. Against the $1.66 in dividends per share that were paid during the year, this is equivalent to a 59% adjusted EPS payout ratio.
And Leggett & Platt's adjusted EPS payout ratio will remain sustainable in 2022. This is because the stock is expecting midpoint adjusted EPS of $2.85 in 2022 ($2.70 to $3.00 according to page 1 of 6 of Leggett & Platt's Q1 2022 earnings press release). Compared to the $1.72 in dividends per share that I expect will be paid in 2022 (assuming a 4.8% increase in the quarterly dividend per share will be announced in the days ahead), this is a 60.4% adjusted EPS payout ratio.
Analysts anticipate that Leggett & Platt will deliver 5.2% annual earnings growth over the next five years. Coupled with a payout ratio that could slightly expand over the long term, I believe the stock will generate 5.5% annual dividend growth over the long haul.
The Company Had A Great First Quarter
Leggett & Platt reported encouraging results for the first quarter of this year.
The company reported a first-quarter record of $1.32 billion in trade sales. This works out to an impressive 14.9% growth rate over the year-ago period (all details sourced from page 3 of 6 of Leggett & Platt's Q1 2022 earnings press release).
This was largely driven by 13% year-over-year organic sales growth. Leggett & Platt was able to pass its increased raw materials costs onto its customers through 18% price hikes. The company's customers were largely willing to pay these increased prices since volumes only declined 4%. And an unfavorable foreign currency translation headwind of 1% also partially offset the sales growth from Leggett & Platt's raw material-related selling price increases (all data points according to page 1 of 6 of Leggett & Platt's Q1 2022 earnings press release).
The company's acquisition of Kayfoam in its Bedding Products segment contributed to the other 2% of its sales growth during the quarter (figure per pages 1-2 of 6 of Leggett & Platt's Q1 2022 earnings press release).
Moving down to the bottom line, Leggett & Platt posted a first-quarter record of $0.66 in adjusted EPS. This equates to a 3.1% year-over-year growth rate (details sourced from page 1 of 6 of Leggett & Platt's Q1 2022 earnings press release).
Unsurprisingly, Leggett & Platt's margins declined 80 basis points year-over-year to 6.8% in the first quarter. This is why the company's adjusted EPS growth meaningfully lagged its trade sales growth (data points according to page 3 of 6 of Leggett & Platt's Q1 2022 earnings press release).
In a difficult operating environment, Leggett & Platt produced strong operating results. And the company also remains reasonably solvent.
This is supported by the fact that Leggett & Platt's interest coverage ratio edged higher from 6.9 in the first quarter of 2021 to 7.1 in the first quarter of this year (figures per page 3 of 6 of Leggett & Platt's Q1 2022 earnings press release).
Overall, Leggett & Platt is a fundamentally healthy company. And the stock could be an excellent long-term compounder at the right valuation.
Risks To Consider
Leggett & Platt is a wonderful business. But even the best businesses aren't invincible. Here are a couple of risks that investors will need to monitor going forward.
The first risk to Leggett & Platt is the accelerating inflation. The Consumer Price Index increased 8.5% year-over-year in March 2022, which was the largest increase since December 1981. Leggett & Platt saw little resistance from customers with its recent price hikes. But as inflation continues to rise, there is no guarantee that the company will be able to replicate this going forward.
The other related risk facing Leggett & Platt is that the Federal Reserve needs to thread the needle on rate hikes. If hikes are either too much or not enough, the U.S. economy could enter into a recession. This would result in a temporary downturn in Leggett & Platt's financial results and could cause further downside in the share price.
The Stock Is Moderately Discounted
Leggett & Platt also appears to be cheaply priced. This conclusion can be reached with my inputs used in two valuation models.
The first valuation model that I will use to value shares of Leggett & Platt is the dividend discount model, which is comprised of three inputs.
The first input into the DDM is the expected dividend per share, which is a stock's annualized dividend per share. Leggett & Platt's annualized dividend per share is currently $1.68. But I will assume that the annualized dividend per share will soon be raised to $1.76.
The next input for the DDM is the cost of capital equity, which is another term for the annual total return rate that an investor requires from their investments. My personal preference is for 10% annual total returns.
The final input into the DDM is the annual dividend growth rate or DGR over the long run.
Accurately forecasting the long-term DGR requires investors to consider numerous factors: These include a stock's payout ratios (and whether those payout ratios are poised to remain unchanged, expand, or contract in the future), annual earnings growth potential, the health of a stock's balance sheet, and industry fundamentals.
As I noted above, I will use a 5.5% annual dividend growth rate for the dividend discount model.
Plugging these inputs into the dividend discount model, I come out to a fair value of $39.11 a share. This signals that Leggett & Platt's shares are trading at a 5.6% discount to fair value and can provide a 5.9% upside from the current price of $36.92 a share (as of May 5, 2022).
The second valuation model that I'll utilize to estimate the fair value of shares of Leggett & Platt is the discounted cash flows model. Like the dividend discount model, this model has three inputs.
The first input for the DCF model is a stock's earnings over the last 12 months. Leggett & Platt has generated $2.80 in adjusted EPS in the past four quarters.
The second input into the DCF model is growth assumptions.
I'm assuming a 4.5% annual adjusted EPS growth rate for the next five years and deceleration to 3.5% in the years that follow.
The third input for the DCF model is the discount rate, which is the annual total return rate that an investor requires. I will again use a discount rate of 10%.
Using these inputs, I get a fair value of $46.53 a share. This means that Leggett & Platt's shares are priced at a 20.7% discount to fair value and offer 26% capital appreciation from the current share price.
Averaging these two fair values out, I compute a fair value of $42.82 a share. This implies that shares of Leggett & Platt are trading at a 13.8% discount to fair value and offer a 16% upside from the current share price.
Summary: A High Yielder With Decent Growth Potential
Leggett & Platt offers income investors an intriguing combo of safe yield and solid future dividend growth prospects. This is because the stock's dividend payout ratio of around 60% is generous to shareholders. But at the same time, it should give the stock room to keep investing in its business to generate mid-single-digit annual adjusted EPS growth.
And Leggett & Platt is further bolstered by fair financial conditioning, which is evidenced by its improving interest coverage ratio. Yet the stock looks to be trading at a 14% discount to fair value.
Finally, Leggett & Platt's 4.6% yield, 5% to 6% annual earnings growth outlook, and 1.5% annual valuation multiple expansion potential over the next decade make the stock a nice buy to gradually build wealth.
Kody's Dividends
Hi, my name is Kody. Aside from my four to five weekly articles here on Seeking Alpha, I am also a contributor to Sure Dividend, Dividend Kings, and iREIT on Alpha. I have been investing since September 2017 and interested in dividend investing since about 2009.Since July 2018, I have ran Kody's Dividends. This is a blog that is documenting my journey towards financial independence using dividend growth investing as the means to transform the dream of financial independence into a reality. It's also the inspiration of my pseudonym here on Seeking Alpha.By God's grace, I owe everything to my blog for introducing me to the Seeking Alpha community as an analyst. That's my story and I hope you enjoy my work examining dividend growth stocks and the occasional growth stock!
Analyst’s Disclosure: I/we have a beneficial long position in the shares of LEG either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
