Six stocks were added to our Dividend Growth Stocks Model Portfolio this month, which was made available to members on April 28, 2022.
Recap From March’s Picks
On a price return basis our Dividend Growth Stocks Model Portfolio (-4.1%) outperformed the S&P 500 (-9.3%) by 5.2%, and on a total return basis the Model Portfolio (-4.0%) outperformed the S&P 500 (-9.3%) by 5.3%. The best performing stock was up 12%. Overall, 24 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from March 30, 2022 through April 26, 2022.
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: Texas Instruments, Inc. (TXN: $170/share)
Texas Instruments, Inc. (TXN) is the featured stock from April’s Dividend Growth Stocks Model Portfolio.
Texas Instruments has grown revenue by 3% compounded annually and net operating profit after-tax (NOPAT) by 11% compounded annually over the past decade. Texas Instruments’ NOPAT margin improved from 20% in 2011 to 45% over the trailing twelve months (TTM), while the company’s invested capital turns rose from 0.8 to 0.9 over the same time. Rising NOPAT margins and invested capital turns drove Texas Instruments’ return on invested capital (ROIC) from 15% in 2011 to 40% over the TTM.
Figure 1: Texas Instruments’ NOPAT & Revenue Since 2011
Sources: New Constructs, LLC and company filings
FCF Exceeds Dividends by Wide Margin
Texas Instruments has increased its dividend in each of the past 18 years. The company increased its regular dividend from $2.12/share in 2017 to $4.21/share in 2021, or 19% compounded annually. The current quarterly dividend, when annualized, equals $4.60/share and provides a 2.7% dividend yield.
More importantly, Texas Instruments’ strong free cash flow (FCF) easily exceeds the company’s growing dividend payments. From 2017 – 2021, Texas Instruments’ cumulative $28.1 billion (18% of current market cap) in FCF is nearly double the $15.0 billion in dividends paid out, per Figure 2. Over the TTM, the company generated $7.0 billion in FCF and paid out $4.4 billion in dividends. Figure 2 also shows that Texas Instruments’ FCF significantly exceeded its dividend payments in each of the past five years.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Sources: New Constructs, LLC and company filings
Companies with FCF well above dividend payments provide higher quality dividend growth opportunities because we know the company 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.
Texas Instruments Has Upside Potential
At its current price of $170/share, TXN has a price-to-economic book value (PEBV) ratio of 1.2. This ratio means the market expects Texas Instruments’ NOPAT to grow to no more than 20% above current levels. This expectation seems overly pessimistic for a company that has grown NOPAT by 16% compounded annually over the past five years.
If Texas Instruments maintains TTM NOPAT margins of 45% and the company grows NOPAT by 6% compounded annually for the next decade, the stock is worth $213/share today – a 25% upside. See the math behind the reverse DCF scenario.
Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Texas Instruments’ 2.7% 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
Below are specifics on the adjustments we make based on Robo-Analyst findings in Texas Instruments’ 10-K and 10-Qs:
Income Statement: We made $664 million in adjustments with a net effect of removing $204 million in non-operating expenses (1% of revenue). Clients can see all adjustments made to Texas Instruments’ income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: We made $20.2 billion in adjustments to calculate invested capital with a net decrease of $1.5 billion. The most notable adjustment was $7.7 billion (35% of reported net assets) related to goodwill. Clients can see all adjustments made to Texas Instruments’ balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: We made $19.9 billion in adjustments with a net effect of decreasing shareholder value by $451 million. The most notable adjustment to shareholder value was $9.4 billion in excess cash. This adjustment represents 6% of Texas Instruments’ market value. Clients can see all adjustments to Texas Instruments’ valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on May 6, 2022.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
 Our research utilizes our Core Earnings, a more reliable measure of profits, as proven in Core Earnings: New Data & Evidence, written by professors at Harvard Business School (HBS) & MIT Sloan and published in The Journal of Financial Economics.