Nine new stocks make our Dividend Growth Stocks Model Portfolio this month, which was made available to members on April 29, 2021.
Recap From March’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (+1.9%) underperformed the S&P 500 (+5.4%) by 3.5% from March 26, 2021 through April 27, 2021. On a total return basis, the Model Portfolio (+2.1%) underperformed the S&P 500 (+5.4%) by 3.3% over the same time. The best performing stock was up 19%. Overall, 8 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from March 26, 2021 through April 27, 2021.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research. Our proprietary Robo-Analyst technology[1] scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks[2] to produce an unrivaled database of fundamental data.
The methodology for this model portfolio mimics an All-Cap Blend style with a focus on dividend growth. Selected stocks earn an Attractive or Very Attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.
Featured Stock From April: Johnson & Johnson (JNJ: $168/share)
Johnson & Johnson (JNJ) is the featured stock from April’s Dividend Growth Stocks Model Portfolio.
We originally made Johnson & Johnson a Long Idea in February 2020 and reiterated it in January 2021. Despite underperforming the S&P 500, JNJ remains undervalued.
Johnson & Johnson has grown revenue and net operating profit after-tax (NOPAT) by 3% compounded annually over the past 10 years. The firm’s trailing-twelve-month NOPAT margin sits at 21%, which also equals the company’s average margin since 2010.
Figure 1: Johnson & Johnson’s NOPAT & Revenue Since 2010
Sources: New Constructs, LLC and company filings
Steady Dividend Growth Supported by FCF
Johnson & Johnson has increased its regular dividend in every year for the last 59 years and from $0.97/share in 1998 to $4.04/share in 2020, or 7% compounded annually. The current quarterly dividend, when annualized, equals $4.24/share and provides a 2.4% dividend yield.
More importantly, Johnson & Johnson’s strong free cash flow (FCF) supports the firm’s growing dividend payments. Johnson & Johnson generated a cumulative $47.7 billion (11% of current market cap) in FCF while paying $47.5 billion in dividends from 2016 to 2020, per Figure 2. In the TTM period, Johnson & Johnson generated $14.5 billion in FCF and paid $10.6 billion in dividends.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Sources: New Constructs, LLC and company filings
Companies with FCF well in excess of dividend payments provide higher quality dividend growth opportunities because we know the firm generates the cash to support a higher dividend. On the other hand, the dividend of a company where FCF falls short of the dividend payment over time cannot be trusted to grow or even maintain its dividend because of inadequate free cash flow.
JNJ Has Upside Potential
At its current price of $168/share, JNJ has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects Johnson & Johnson’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 7% compounded annually over the past two decades.
Even if Johnson & Johnson’s NOPAT margin falls to its 20-year low of 17% (compared to 21% in 2020) and the firm grows NOPAT by just 3% compounded annually for the next decade, the stock is worth $219/share today – a 30% upside. See the math behind the reverse DCF scenario. Add in Johnson & Johnson’s 2.4% dividend yield and history of dividend growth, and it’s clear why this stock is in April’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Fact: we provide superior fundamental data and earnings models – unrivaled in the world.
Proof: Core Earnings: New Data and Evidence, forthcoming in The Journal of Financial Economics.
Below are specifics on the adjustments we make based on Robo-Analyst findings in Johnson & Johnson’s filings:
Income Statement: we made $5.2 billion in adjustments with a net effect of removing $2.5 billion in non-operating expenses (3% of revenue). See all adjustments made to Johnson & Johnson’s income statement here.
Balance Sheet: we made $87.9 billion of adjustments to calculate invested capital with a net increase of $9.2 billion. The most notable adjustment was $15.2 billion (12% of reported net assets) in other comprehensive income. See all adjustments to Johnson & Johnson’s balance sheet here.
Valuation: we made $76.2 billion in adjustments with a net effect of decreasing shareholder value by $30.4 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $22.9 billion in excess cash. This adjustment represents 5% of Johnson & Johnson’s market value. See all adjustments to Johnson & Johnson’s valuation here.
This article originally published on May 7, 2021.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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[1] Harvard Business School features our research automation technology in the case Disrupting Fundamental Analysis with Robo-Analysts.
[2] See how our models and financial ratios are superior to Bloomberg and Capital IQ’s (SPGI) analytics in the detailed appendix of this paper.