Prudential Financial: A High-Yielding Dividend Stock On Sale (NYSE:PRU)

A common expression within the dividend growth investing community is as follows: The safest dividend is the one that’s just been raised.

Upon further thought, this makes plenty of sense. When a Board of Directors ups the dividend, it is usually an admission of confidence in the future direction of the company. There are exceptions to the rule, but few boards, in my opinion, would announce a dividend hike only to take it back shortly thereafter.

That’s because depending on the profile of a dividend stock, shareholders tend to be income-oriented. Thus, such a betrayal of trust stemming from a dividend hike and an unforeseen cut would result in a sharp selloff of the stock. Since most people act in their self-interest, it’s unlikely that a dividend hike would be announced by a company only to be taken back shortly thereafter. These circumstances could potentially lead to a shareholder revolt and maybe even an ouster of the board members responsible, which wouldn’t be in the interest of the latter party.

One company I own that recently upped its quarterly dividend per share by 4% to $1.30 was Prudential Financial, Inc. (NYSE:PRU). Since I last covered the stock in November, shares have gained 17% versus the 14% gains of the S&P 500 index (SP500). I will dig into Prudential’s fundamentals and valuation to explain why I still like it enough to maintain my buy rating.

Prudential’s 4.9% dividend yield is moderately above the current 4.2% yield of 10-year U.S. treasury notes. The company’s payout also should have room to keep climbing higher in the years ahead.

For one, Prudential’s 39% EPS payout ratio is below the 50% EPS payout ratio that rating agencies prefer from their industry. The company’s 38% debt-to-capital ratio is elevated beyond the 20% or better debt-to-capital ratio that rating agencies desire from the industry. Prudential’s low payout ratio and reputation as an industry leader compensate for this higher debt-to-capital ratio, however.

This is why S&P awards an A credit rating to the company on a stable outlook. That implies the probability of Prudential defaulting on its debt over the next 30 years is 0.66% per rating agencies.

Additionally, the risk of a dividend cut from the company is 0.5% in the next average recession. This risk would remain subdued at 2% in the next severe recession.

The appeal to Prudential doesn’t end at its fundamentals, either; the valuation appears to be attractive as well. According to the 10-year and 25-year dividend yields and P/E ratios, the asset manager and insurer could be worth $114 a share. As I will elaborate on, I believe the fundamentals demonstrate Prudential to be intact. That’s why I believe the company is worthy of reverting to its historical fair value. Relative to the current $107 share price (as of February 12, 2024), this suggests shares of Prudential are 6% undervalued.

If the company returns to fair value and grows as anticipated, here are the total returns that it could produce over the coming decade:

• 4.9% yield + 8.4% FactSet Research annual growth consensus + a 0.6% annual valuation multiple expansion = 13.9% annual total return potential or a 267% 10-year cumulative total return versus the 10% annual total return potential of the S&P or a 159% 10-year cumulative total return

On Track To Return To Growth And Highly Liquid

Prudential concluded 2023 with decent results in the fourth quarter that ended Dec. 31. The company missed the analyst consensus after-tax adjusted operating income per share by $0.09. However, Prudential’s after-tax adjusted operating income per share increased by 3.6% year-over-year to $2.58 during the quarter.

These results were fueled by a great showing in the company’s U.S. Businesses segment. High interest rates resulted in an improved investment spread for Prudential. Thanks to cost discipline, the segment’s expenses were also lower than the year-ago period. These two tailwinds more than offset the headwind of lower net fee income. That’s how adjusted operating income soared 39.2% higher year-over-year to $988 million for the fourth quarter.

Outsized growth in the U.S. Businesses segment was somewhat countered by more headwinds than tailwinds in the Prudential Global Investment Management or PGIM segment and the International Businesses segment.

In the former, lower other related revenue and higher expenses canceled out the benefit of assets under management, growing by 6% over the year-ago period to $1.3 trillion in the fourth quarter. This is why adjusted operating income fell by 25.2% year-over-year to $178 million during the quarter.

In the International Businesses segment, unfavorable policyholder behavior led to higher insurance claims. This was only partially neutralized by lower expenses, which led adjusted operating income to dip by 8.1% over the year-ago period to $748 million for the fourth quarter.

The other factor that contributed to Prudential’s after-tax adjusted operating income per share growth had to do with a lower share count. The company’s share repurchases helped the diluted share count to fall by 2.3% year-over-year to 361 million in the fourth quarter.

Moving forward, analysts are forecasting 17% after-tax adjusted operating income per share growth in 2024 to $13.54, 6% in 2025 to $14.4, and 7% in 2026 to $15.38 per FAST Graphs.

I agree with these assumptions for a few reasons, starting with the $1 billion share repurchase plan that was authorized for 2024. At the current $38 billion market cap, that would represent up to 2.6% of shares being retired this year. This would be one element that would lift Prudential’s after-tax adjusted operating income per share.

On the growth front, the company also expanded the third-party distribution of its products in Latin America through its partnership with MercadoLibre, Inc. (MELI). This helped the company to close in on the milestone of 300,000 active policies in Latin America per Chairman and CEO Charles Lowrey’s opening remarks during the Q4 2023 earnings call. Aimed at addressing customer needs in Japan, the company also launched additional inheritance products and new investment products. These initiatives should help to power growth in the bottom line.

Moving to the balance sheet, Prudential had $4.1 billion in liquidity as of Dec. 31. This is comfortably within the $3 billion to $5 billion in parent company liquidity that Prudential targets. If a prolonged recession happened, the company would be well-equipped to handle such a situation. That’s why Prudential enjoys an A rating from S&P as I noted previously, as well as A3 (A- equivalent rating) and A- ratings from Moody’s and Fitch, respectively (unless noted or hyperlinked, all details were sourced from Prudential’s Q4 2023 Earnings Press Release and Prudential’s Q4 2023 Earnings Presentation).

Expect More Of The Same With Dividend Growth

Prudential has upped its dividend for 16 consecutive years now (per Prudential’s Q4 2023 Earnings Press Release). In the last few years, annual dividend growth has been around 4%. I would anticipate that such growth will persist.

Prudential is slated to pay $5.20 in dividends per share in 2024. Against the $13.54 in after-tax adjusted operating income per share that is projected for 2024 per Seeking Alpha, that would be a manageable 38.4% payout ratio.

Risks To Consider

Prudential is a solid company, but some risks are worth noting.

As an insurer, Prudential faces insurance risk. If the company underestimates mortality and morbidity rates on its policies, it will encounter unfavorable insurance underwriting. That would weigh on Prudential’s financial results. Conversely, overestimating mortality and morbidity rates would result in higher than necessary insurance premiums. This could lead customers to find lower premiums elsewhere, which may impact Prudential’s market share.

Another risk to the company is that there is the potential that it could mismanage its $376 billion investment portfolio. This is unlikely, with the risk management and diversification shown above. However, it is still probably wise to monitor the underlying quality of this investment portfolio over time to make sure it remains sound.

Summary: The Risk/Reward Proposition Is Interesting To Me

Trading at a blended P/E ratio just below 9, shares of Prudential could be a decent value right now compared to the normal P/E ratio of 10.3 per FAST Graphs. This is especially the case with the fundamentals justifying a return to a multiple of around 10 in my opinion. If that were to happen, and it grew as forecasted, the stock could deliver nearly 50% cumulative total returns through 2025. Due to this potential upside, I am reiterating my buy rating.