3 Reasons to Buy This Undervalued Dividend Stock

German industrial giant Siemens (SIEGY +4.02%) stands out as a beacon of value in an increasingly expensive market. The stock offers investors a compelling mix of exposure to growth industries (automation, industrial software, smart infrastructure, electrification) balanced by earnings from its majority holding in a world-class healthcare company, Siemens Healthineers. Sporting a dividend that at current share prices yields 2.6% and trading at attractive valuations, Siemens would make a strong addition to many portfolios. 

Image source: Getty Images.

How Siemens makes money 

Here's a quick look at the key industrial businesses that provide the bulk of Siemens earnings. For reference, the total company numbers differ from the total industrial businesses numbers for a few reasons.

Siemens also owns a financial services business and a diverse collection of small businesses which provide customized products (mechanical drives, wind energy generators, logistics, etc.) lumped together in its financials as "portfolio companies."

Mobility (rail infrastructure, rolling stock, traffic systems) is probably the least exciting of Siemens' main industrial businesses, but even it has good growth prospects. The segment won nearly 10 billion euros worth of orders in the first three quarters of its fiscal 2021 -- 44% more than the prior-year period's revenue of 6.7 billion euros. These included orders of 2.8 billion euros from U.S. rail system Amtrak. Management expects its mobility revenue will grow in the mid-single-digit percentage range in fiscal 2021.

Data source: Siemens presentations. *Siemens owns a near 75% stake in Siemens Healthineers.

Now it's time to turn to the more exciting parts of the portfolio.

Siemens is undervalued compared to its peers

Siemens digital industries and smart infrastructure segments cater to some fascinating end markets, and they command leading positions in them. Moreover, nearly all the companies that Siemens competes with are valued at significantly higher premiums.

Its digital industries unit competes with Emerson Electric, ABB, Schneider Electric, Rockwell Automation in factory automation, process automation, motion control, and PTC and Dassault Systemes in industrial software. So while it's unreasonable to expect a software company-type valuation for Siemens, it's worth noting that software provides 28% of the segment's revenue.

Image source: Getty Images.

Moreover, the segment actively invests in the software business -- it acquired five software companies recently. CEO Roland Busch stated that "a particular focus is on our software and digital service offerings" during the recent earnings call. In addition, Siemens trades at a discount to its automation-focused peers like Rockwell and Emerson Electric.

Siemens' digital industries peers are highly rated because industrial companies are increasingly adopting automation to boost productivity. In addition, productivity is significantly enhanced by an explosion of Internet of Things-based digital solutions, which help owners run their physical assets better.

Data by YCharts

It's a similar story with Siemens' smart infrastructure segment. The segment plays to the theme of growing electrification in the economy, the increasing use of building controls, and relatively low growth electrical products. Competitors include ABB, Johnson Controls, Schneider Electric, and Honeywell.

Many investors are excited by Johnson Controls' ability to profit from increasing demand for building controls that help reduce carbon emissions. Honeywell recently upgraded its full-year growth expectations for its Honeywell building technologies segment, so why does the market appear to be undervaluing Siemens?

Siemens Healthineers

Siemens' stake in the publicly listed medical technology company, Siemens Healthineers (SMMNY +1.93%), provides it with valuable earnings and free cash flow even during economic downturns. Key competitors in imaging include GE Healthcare and Philips, while Roche and Abbott Labs provide competition in diagnostics. Meanwhile, Varian Medical Systems (a business recently acquired by Siemens Healthineers for $16.4 billion) competes with Elekta. While the comparisons are not exact, it's still notable that Siemens' overall valuation stands again at the bottom of the pile. 

The key attraction of Siemens Healthineers to Siemens is that it gives the company very valuable earnings and cash flow to support the company in any economic downturn. 

Data by YCharts

Siemens absolute valuation

Appreciating that these comparisons aren't exact, and that Siemens probably has a conglomerate discount baked into its valuation, the stock still looks undervalued.

That view strengthens when looking at its absolute valuation, too. Wall Street analysts forecast the company will generate 6.2 billion euros in FCF in 2021 and 6.9 billion euros in FCF in 2022. Those figures would have Siemens trading at a ratio of 18.1 times FCF in 2021 and 16.2 times FCF in 2022. Given that industrial conglomerates are often seen as a reasonable value when they trade at a ratio of 20 times FCF, the stock appears cheap.

Historically speaking, Siemens valuation isn't far off what the stock has traded at, but the jettisoning of the power and gas businesses and repositioning toward growth industries suggests the stock deserves a higher valuation and can grow its earnings and dividend at a higher rate than in the past. 

Throw in its exciting growth opportunities in digital industries, smart infrastructure, and its stake in Siemens Healthineers, and the stock looks like one of the best investing options in the industrial sector.