Medtronic (MDT) is one of the largest healthcare companies in the world. It manufactures and sells medical devices.

It was founded in 1949 as a medical equipment repair shop by Earl Bakken and his brother-in-law, Palmer Hermundslie. Today, Medtronic has more than 85,000 employees, and operates in more than 155 countries around the world.

Medtronic is has raised its dividend each year for the past 39 consecutive years.

Source: Medtronic Investor Relations

The company’s history of rising dividends makes it one of only 50 Dividend Aristocrats – stocks with 25+ years of consecutive dividend increases.You can see the full Dividend Aristocrats list here, to find more high quality dividend growth stocks like Medtronic.

Medtronic has been a fantastic dividend growth stock. According to the company, over the 39-year period it has raised its dividend by 18% per year on average. In the past 10 years, it has nearly quadrupled its dividend.

Business Overview

Medtronic operates in four segments, which are cardiac and vascular, restorative therapies, minimally invasive therapies, and diabetes. Its revenue breakdown according to operating segment is as follows:

Source: Investor Relations

All told, Medtronic’s lineup of devices and health care products treat nearly 40 different medical conditions. Its four operating segments each manufacture medical devices to serve a different market. The company has had great success with its diversified business model. Over the past decade, the company grew earnings-per-share by 7.9% compounded annually.

Last year, Medtronic increased its organic revenue, excluding the effects of foreign exchange and acquisitions, by 7% year over year.

It is off to a good start to the new fiscal year as well. Revenue, excluding currency fluctuations and the extra week of the prior fiscal year, rose 5% last quarter. The best-performing segment for the company was its diabetes group, which grew revenue in the high single-digit range on a constant-currency basis.

Medtronic management has pinpointed the diabetes group as a focal point moving forward. It is currently the smallest business segment, but that stands to change. Growth in this area is higher than the other business segments. For now, the diabetes group is Medtronic’s smallest segment, but it is a high-growth area. Management intends to grow the number of patients it serves from 1 million to 20 million, by 2020.

Growth Prospects

Medtronic management has set an ambitious goal over the next five years, which is to generate $40 billion of free cash flow over that period.

Source: 2016 Morgan Stanley Global Healthcare Conference, page 3

Medtronic has a multi-faceted approach to reach this goal. It plans to increase revenue by mid-single digits on a constant currency basis, driven by acquisitions and innovation. Management expects to generate double-digit earnings-per-share growth, from a combination of revenue growth, share repurchases, and tight cost controls.

The company’s revenue and earnings-per-share growth forecasts are ambitious, but attainable. That is because Medtronic should benefit from a strong fundamental tailwind going forward, which is the aging U.S. population. According to the Pew Research Center, there are 75 million Baby Boomers, those aged 51-69 years, in the U.S. As the Baby Boomers age, it should boost demand for health care and medical devices over the long term.

Another growth catalyst for earnings-per-share is the $50 billion acquisition of fellow device maker Covidien. This huge acquisition provides Medtronic with a large portfolio of hospital supplies, adding size and scale to the company. In addition, earnings-per-share are likely to grow further because of significant cost synergies. Medtronic expects to realize at least $850 million in cost cuts by fiscal year 2018.

Competitive Advantages & Recession Performance

The main competitive advantage for Medtronic is its research and development capabilities. The company holds a massive intellectual property portfolio of more than 53,000 patents.

Medtronic spends approximately $2 billion each year on research and development. Such a robust level of spending creates the necessary innovation to deliver new products designed to meet consumers’ needs.Strong research and development spending has given the company a robust product pipeline.

Another competitive advantage is Medtronic’s huge size, which leads to economies of scale. Medtronic has a market cap of more than $110 billion. This allows it to keep a low cost of capital, moderate expenses, and generate high returns on capital.

There are also significant barriers to entry, which keeps competitors at bay. Duplicating Medtronic’s supply chain and high-quality brand perception are very difficult.

These qualities allowed Medtronic to sail through the Great Recession unscathed. In fact, it managed to increase its earnings-per-share in each year of the recession:

• 2007 EPS of $2.61
• 2008 EPS of $2.92 (12% increase)
• 2009 EPS of $3.22 (10% increase)
• 2010 EPS of $3.37 (5% increase)

This indicates the benefit of a recession-resistant business model. Health care is one thing that consumers cannot do without, even when the economy enters recession. It is a great sign for long-term investors that Medtronic has the ability to grow earnings in both economic recessions and expansions.

Valuation & Expected Total Returns

Medtronic stock trades for a price-to-earnings ratio of 18.7 (using adjusted earnings). This is a significant discount to the S&P 500 Index, which has a price-to-earnings ratio of 24.5.

As a result, Medtronic stock appears undervalued. It would seem that Medtronic deserves at least a market multiple, given its strong performance and future growth catalysts.

Separately, investors can reasonably expect 8% to 10% annual earnings-per-share growth moving forward. As a result, when combined with the company’s 2% dividend yield, there is potential for 10%-12% annualized returns from Medtronic stock.

Final Thoughts

Medtronic stock has a 2.1% dividend yield, which is essentially in-line with the average dividend yield in the S&P 500. As a result, it should not be viewed as a high-yield stock.

However, it is a very good stock pick for dividend growth investors. Its underlying business model is strong. It should grow earnings-per-share at high rates moving forward, thanks to many growth catalysts including the aging population.

This should provide the company with strong earnings-per-share growth. In turn, investors can expect this to result in high dividend growth, such as its 13% dividend increase for 2016.

The company’s combination of a lower-than-average price-to-earnings ratio, long dividend history, solid growth prospects, and low payout ratio of around 30% give Medtronic a rank in the Top 25% of stocks with 25+ years of steady or rising dividends using The 8 Rules of Dividend Investing.