MENU

Characteristics of a Successful Value Investment

I will use Algonquin Power & Utilities Corp. (TSX:AQN)(NYSE:AQN) as an example to discuss potential characteristics of a successful value investment. Algonquin shares have returned about 24.7% in the last 12 months. These results beat the average market returns of 10% per year. Let’s explore why that may be the case.

Safe dividend

Not all value stocks offer a dividend, but when they do, the dividend can only boost shareholders’ overall returns. Even after the nice price appreciation, the stock still offers an above-average yield of 4.4%. This dividend is supported by the utility’s growing earnings and operating cash flow.

Growing dividend

Paying a dividend is nice, but a stock that offers a growing dividend is even better. Over time, a stock becomes more valuable to its shareholders solely by the growing income they receive.

Early in the year, Algonquin hiked its dividend per share by 10%, representing its seventh consecutive year of dividend growth. Management expects the company to grow its dividend by 10% per year through 2021. This means that without relying on price appreciation, shareholders can get a yield on cost of about 6.5% by 2021.

Good execution

Management has shown it can execute. Since 2010, it has grown the company nicely. That’s why Algonquin started offering a growing dividend to increase shareholder value.

Its recent achievements include the successful acquisition of Empire, a regulated electric, gas, and water utility serving customers in four states: Missouri, Kansas, Oklahoma, and Arkansas. So, Algonquin now serves about 780,000 customers and has a net capacity of more than 1,400 MW for its ~263,000 electric customers.

In Q1, Algonquin had some wind and solar facilities come into service. As a result, the utility now has over 1,500 MW of renewable power-generating capacity, of which 88% have long-term power-purchase agreements with a weighted average term of 16 years remaining.

Reasonable valuation

Management does its part by running the company well. Then it’s up to investors to buy at a reasonable valuation. If they overpay for the shares, it’ll take time for earnings and cash flows to catch up.

At about $14 per share, Algonquin trades at roughly a price-to-cash-flow multiple of 11, which is still reasonable for its growth potential.

Share price cooperation

If management continues to execute, shares should continue on a steady climb, barring any major market corrections. However, no one can guarantee that share prices will cooperate.

For a stable utility, such as Algonquin, I think it will. Since 2010, Algonquin shares have delivered total returns of 313%, or annualized returns of 21.1%. This more or less matches its 12-month returns.

One last characteristic

Typically, smaller companies have a better chance of outperforming their bigger peers, given the former group has good management and shareholders pay a reasonable valuation for the shares.

A $500 million company can more easily double to $1 billion than for a $5 billion company to double to $10 billion. Algonquin is categorized as a mid-cap utility, and it will have higher growth potential than large-cap utilities.

Is Algonquin a good buy now?

There’s no margin of safety in Algonquin’s shares. However, it’s reasonably priced. Investors looking for a stable, growing dividend can consider buying some shares now or wait to add on any dips.

5 stocks we like better than Algonquin

When investing Guru Iain Butler and his shrewd team of analysts have a stock tip, it can pay to listen. After all, the newsletter they began just three years ago, Stock Advisor Canada, is already beating the market by 9.6%. And their Canadian picks have literally doubled the market.

Iain and his team just revealed what they believe are the five best stocks for investors to buy right now... and Algonquin wasn't one of them! That's right - they think these five stocks are even better buys.

*returns as of 5/30/17

Fool contributor Kay Ng owns shares of ALGONQUIN POWER AND UTILITIES CORP.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.