Power Corporation of Canada (TSE:POW) is a large Canadian financial holding company that currently sports a 5.9% forward dividend yield. As per our estimates, POW looks undervalued, making it a solid stock for income investors to consider, with the caveat that it’s likely not a stock that could make you rich overnight.
While POW has provided satisfactory returns in the past, we would prefer a stock with more growth potential at its current dividend yield, at least in this market environment, leaving us neutral on the company. Nonetheless, let’s analyze its dividend and valuation.
A Reliable, Growing Dividend
When seeing a high-yielding dividend stock, you may wonder if its dividend is safe. Well, Power Corporation has a 70% payout ratio, meaning that it still has 30% of its earnings left over after paying dividends to its shareholders. This, to us, looks like a relatively safe payout ratio that also leaves room for further increases. It’s also worth noting that POW’s five-year average payout ratio is about 58%, so it’ll be interesting to see if its payout ratio keeps trending higher or not.
The firm’s dividend per share has grown at a compound annual growth rate (CAGR) of 6.7% over the past five years, which is good (but not extraordinary) considering its already-high yield. Moreover, analysts estimate its dividend rate to increase to C$2.16 by 2024 (currently C$2.10), which would give it a yield of 6.07% at the stock’s current price.
Power Corporation Stock is Undervalued. Here’s Why
Earlier, we made the claim that POW stock is undervalued. To prove this, we will use the excess returns model, which is more appropriate for financial companies because they tend to have volatile free cash flows.
As a result, trying to create forecasts for them doesn’t work well. The excess returns model allows us to use historical numbers instead, which are tangible. There are a few steps to follow for this valuation method.
First, you calculate a company’s excess return, meaning the spread between its return on equity (ROE) and its cost of equity; a higher ROE than the cost of equity is a good thing. Next, you calculate its terminal value. Add them up, and you get your valuation. Here’s the formula:
- Excess Return = (Average ROE – Cost of Equity) x Book Value Per Share
- Terminal Value = Excess Return / (Cost of Equity – Growth Rate)
- Fair Value = Book Value Per Share + Terminal Value
We will use the following assumptions for our calculations:
Average return on equity (ROE): 10% (five-year average)
Cost of equity: 7.9%
Book value per share: C$34.59
Growth rate: 3.07% (used 30-year Government of Canada bond yield as a proxy for long-term growth expectations)
Now that we have our assumptions, we’ll plug them into the formula highlighted above. The figures are in Canadian dollars:
- $0.726 = (0.10 – 0.079) x $34.59
- $15.03 = $0.726 / (0.079 – 0.0307)
- $49.62 = $34.59 + $15.03
Therefore, POW stock is currently worth C$49.62 per this valuation method. Its current share price is C$35.61, making it undervalued.
Is POW Stock a Buy, According to Analysts?
According to analysts, POW stock comes in as a Hold. This is based on eight unanimous Hold ratings assigned in the past three months. Nevertheless, at C$41.45, the average POW stock price target implies 16.4% upside potential.
The Takeaway
With its 5.9% yield and modest growth potential, POW stock can be an attractive stock for conservative, income-oriented investors. Bringing in over C$47 billion in revenue in 2022, Power Corporation certainly looks like a proven financial company that should continue doing well over the long term. Further, the stock appears undervalued based on our valuation method and analyst estimates. Therefore, it’s one worth considering.
