Being an income investor in the current low-yield environment can be overwhelming and feel like you're fighting a losing battle. After all, how can you make your nest egg work for you when the average yield for stocks in the S&P 500 has been sub-1.3% lately and approaching its all-time low of 1.1%?
The yields are so low mostly because the markets have been trading so high lately. Fortunately, there is still hope for income investors and it has nothing to do with the recent market drop. That is, there's hope if investors know where to look.
Income investors looking for a solid yield might want to consider Prudential Financial (PRU -1.40%). This diversified insurer and asset manager actually benefits from steadily rising equity markets. Let's dig into whether Prudential is a buy based on its fundamentals and valuation.
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A massive third-quarter earnings beat
Prudential reported $1.49 billion in non-GAAP (adjusted) after-tax operating income during the third quarter, which works out to $3.78 in adjusted earnings per share (EPS). This represents a 22.7% year-over-year growth rate over the $3.08 in adjusted EPS generated in the year-ago period. Prudential topped analysts' forecasts of $2.68 in adjusted EPS by an astounding 41%, which raises the following question: What led to Prudential's statistically significant earnings beat?
To answer that question, it's important to understand the three main operating segments of Prudential's business (not factoring in the smaller corporate and "other" segments that usually operate at a loss):
- PGIM is the company's investment management business that earns revenue and profits from asset management fees and funding of businesses in their early development stages.
- U.S. businesses provides a variety of services including retirement, group life and disability insurance, individual annuities, and individual life insurance.
- International businesses provides the same services as the U.S. businesses segment, but in countries throughout the world.
The PGIM segment saw its assets under management increase 5% year over year to a record-high $1.51 trillion in the third quarter, which helped to produce record-high asset management fees. But higher expenses and lower investments in businesses more than offset higher asset management fees, which is how the PGIM segment's pre-tax adjusted operating income fell 11.6% year over year to $323 million in the third quarter.
Prudential's U.S. businesses segment is its largest in terms of pre-tax adjusted operating income. The segment's tailwind of higher net fee income due to appreciation in the financial markets was partially offset by unfavorable underwriting results. The unfavorable underwriting results allude to the impact that the coronavirus delta variant had on the life insurance business. According to opening remarks during Prudential's Q3 2021 earnings call from its head of U.S. businesses, Andy Sullivan, the company was expecting 30,000 deaths and actually saw 95,000 in the third quarter. Even with the increase in life insurance payouts stemming from deaths related to COVID-19 during the quarter, Prudential's pre-tax adjusted operating income soared 28.5% year over year to $1.09 billion in the third quarter.
Similar to the U.S. businesses, the international businesses segment faced the headwind of increased COVID-19 deaths as a result of the delta variant. However, the growth of its business and lower expenses in the segment were enough to propel its adjusted operating income 14.5% higher year over year to $887 million during the third quarter.
A rock-solid, dependable dividend
Even with some COVID-19-related headwinds, Prudential's results were excellent in the third quarter, which is encouraging. But the question that dividend investors should be asking is this: Is the stock's earnings power enough to support its generous 4.2% dividend yield?
The average of analysts' (non-GAAP) EPS forecasts for Prudential next year is $12.60. Against an estimated per-share dividend obligation of $4.88 (assuming a 6% raise in the quarterly dividend to $1.22 a share), this works out to an estimated dividend payout ratio of just 38.7% for next year. This ratio builds in a sizable margin of safety for Prudential to continue paying its dividend, even in the event of an economic recession. And analysts are predicting that Prudential will grow its non-GAAP EPS by 8.5% annually over the next five years, likely because rising interest rates will be a boost to the business. Thus, this stock has plenty of room for dividend growth in the medium term.
An attractive blend of value and growth
So, Prudential is a quality business with a fairly protected payout. The only remaining question is whether the stock's current valuation warrants a buy from investors.
At its current share price of around $109, Prudential is trading at a price-to-earnings-growth (PEG) ratio of 0.7. This is a bit lower than the 0.73 PEG ratio average of its industry peers, which suggests that the stock offers investors a better mixture of growth and value than the industry average. That's why Prudential is a great dividend stock for investors to buy on sale.
