BlackRock: Buy This Cheap Stock For The Dividend And Growth Prospects

A recent survey of 1,000 401k plan participants found that the average American believes they will need to save $1.8 million for a comfortable retirement. If you're like most people, this is probably quite a bit of money for you.

The good news is that the earlier you start investing, the more attainable such an otherwise lofty financial goal becomes due to compounding. A $10,000 investment made in BlackRock (NYSE:BLK) in 2003 would now be worth $214,000 with dividends reinvested after having compounded at 16.6% annually. More impressively, you would be collecting over $6,000 in annual dividends from that position - a 60%-plus yield on cost.

Even if you think that you're late to the game with starting to invest, that doesn't subtract from the power of compounding. Great businesses can begin to work wonders over 10-plus years. For the first time since July, let's highlight why BlackRock is a significant holding in my dividend stock portfolio.

A Market-Topping Dividend With Decent Growth Potential

BlackRock is a business with an impressive history of dividend growth, especially over the last decade: The company's average annual dividend growth rate over that time is 11.8% - - well above the financials sector median of 8.1%. This explains why the Seeking Alpha Quant system has awarded the company an A- grade for overall dividend growth. It also helps that its dividend yield is 3%, which is almost double the 1.6% yield of the S&P 500 index.

And if you think that this generous dividend growth has pushed BlackRock's payout ratios up to unsustainable levels, rest assured that isn't the case.

BlackRock recorded $35.36 in adjusted diluted EPS in 2022. Against the $19.52 in dividends per share that were paid during the year, this is an adjusted diluted EPS payout ratio of 55.2%. While this isn't a low payout ratio, it also isn't bad considering that 2022 was likely the trough-adjusted diluted EPS year for BlackRock in the current economic cycle.

Investors will also be relieved to learn that the company logged $5 billion in operating cash flow during 2022. Compared to the $533 million in property and equipment purchases for capital expenditures, this is just over $4.4 billion in free cash flow. Measured up to the $3 billion in dividends paid for the year, this works out to a 67.6% free cash flow payout ratio (details sourced from page 73 of 108 of BlackRock 10-K filing). For the circumstances, the dividend is at low risk of being cut anytime soon.

Coupled with the analyst consensus for adjusted diluted EPS to grow by 10% annually, I can reaffirm my 7.5% annual dividend growth projection over the long run.

The Asset Management Industry's Undisputed Heavyweight Champion

In just 35 years since its founding, BlackRock has taken the asset management industry by storm. The company's $9.4 trillion in assets under management as of June 30 is far and away the most impressive AUM base in the industry.

BlackRock's financial results for the first half of 2023 have been mixed. The asset manager's net revenue dipped by 5.6% year over year to $8.7 billion. Factoring in that BlackRock's AUM is below its all-time high of around $10 trillion set at the end of 2021, this shouldn't be a surprise: The company generates the vast majority of its net revenue from investment advisory fees that are based on its AUM.

BlackRock's adjusted diluted EPS edged higher by 1.9% over the year-ago period to $17.21 during the first half. Disciplined cost management kept the company's expenses in check, which helped its non-GAAP profit margin to rise by about 180 basis points to 29.9% in the first half. Paired with a decrease in BlackRock's diluted share count from share repurchases, this is what pushed adjusted diluted EPS upward while net revenue fell.

BlackRock likely won't have to wait long for a complete recovery in its business. Analysts anticipate that net revenue will surge 11.2% higher in 2024 to $20.2 billion. This should send adjusted diluted EPS soaring by 13.6% to $40.58 (surpassing the all-time high of $40.51 set in 2021). Why do analysts think this will materialize?

For one, BlackRock has a track record of stellar fund performance: 81% of its active assets under management have outperformed the peer median or benchmark over the past five years. Alongside consistent fund launches designed to appeal to a wider client base, this has led to $190 billion in net inflows into BlackRock's funds so far this year. If financial markets merely hold steady or eventually work their way higher from here, the company could certainly put up the growth that analysts are expecting.

Outside of an eventual recovery in fundamentals, BlackRock also is financially sturdy. The company's interest coverage ratio was 27.7 through the first half of 2023. Even in a depression-like economy, BlackRock's earnings could plunge 75% or more and the company should still have the earnings power to remain a going concern (all info according to BlackRock Q2 2023 earnings press release and BlackRock 2023 Investor Day Presentation).

Risks To Consider

BlackRock is a remarkable business. Yet, the company has some risks that investors need to track.

BlackRock has done an excellent job of remaining atop the summit of its industry. But if the company slips up and doesn't meet the needs of clients, competitors could win over business. This could hurt BlackRock's financial results.

The other risk that is more pressing is the potential for an official recession. If the worst-case scenario of a full-blown global recession plays out, financial markets could implode, and BlackRock's AUM could tumble too. While not the consensus forecast, this could lead to a meaningful downside in BlackRock's share price and financial results.

An (Almost) Bargain-Bin Valuation For A Blue-Chip Dividend Stock

BlackRock has been an excellent compounder for shareholders for decades. At the right valuation, the stock has all the potential for that to hold. Let's examine two valuation models to assess the fair value of BlackRock's shares.

The first valuation model that I'll use to value shares of BlackRock is the discounted cash flows model, which has three inputs.

First up is the last 12 months of adjusted diluted EPS. That amount is $35.69 for BlackRock.

The next input for the DCF model is growth predictions. The 6% annual adjusted diluted EPS growth figure that I'll use for the first five years is almost half of the consensus. I'll then assume deceleration to 5% annual adjusted diluted EPS into perpetuity beyond the initial five-year time frame.

The final input into the DCF model is the discount rate, which is the annual total return rate that an investor requires from investments. I will use 10% for this input.

Based on these inputs for the DCF model, I get a fair value of $782.68. This suggests that BlackRock's shares are trading at a 14.3% discount to fair value and offer a 16.7% upside from the current share price of $670.84 (as of September 21, 2023).

The other valuation model that I will utilize to gauge the fair value of shares of BlackRock is the dividend discount model or DDM.

The first input is the annualized dividend per share, which is $20 for BlackRock.

The second input for the DDM is the cost of equity, which is again the annual total return rate. I'll use 10% once more.

The third input into the DDM is the annual dividend growth rate. As I outlined before, I will use 7.5% for this input.

Using these inputs for the DDM, I arrive at a fair value of $800 a share. That means BlackRock's shares are priced 16.1% below fair value and could provide 19.3% capital appreciation at the current share price.

Upon averaging these two fair values, I compute a fair value of $791.34 a share. This implies shares of BlackRock are trading at a 15.2% discount to fair value and offer an 18% upside from the current share price.

Summary: BlackRock Has It All

It's been said that the stock market is a market of stocks. If that's the case, then investors can think of BlackRock as a one-stop shop for all their needs. Want a decent starting dividend? The company has that and the ability to grow it further. Desire respectable earnings growth prospects? BlackRock has you covered. Finally, want a somewhat cheap stock? The asset manager looks to be 15% undervalued based on my valuation models. For these reasons, I view BlackRock as a buy for dividend growth investors.