11 new stocks made August’s Dividend Growth Stocks Model Portfolio, which was made available to members on August 30, 2023.
Recap from July’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (-3.8%) underperformed the S&P 500 (-2.2%) by 1.6% from July 27, 2023 through August 28, 2023. On a total return basis, the Model Portfolio (-3.6%) underperformed the S&P 500 (-2.2%) by 1.4% over the same time. The best performing stock was up 8%. Overall, 13 out of 27 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from July 27, 2023 through August 28, 2023..
This report leverages our cutting-edge Robo-Analyst technology to deliver proven-superior[1] fundamental research and support more cost-effective fulfillment of the fiduciary duty of care.
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 favor long-term capital appreciation over current income, but still appreciate the power of growing dividends.
Featured Stock for August: Steel Dynamics (STLD: $106/share)
Steel Dynamics (STLD) is the featured stock in August’s Dividend Growth Stocks Model Portfolio. We first made Steel Dynamics a Long Idea in June 2023.
Steel Dynamics has grown revenue by 10% compounded annually and net operating profit after tax (NOPAT) by 26% compounded annually since 2012. The company’s NOPAT margin increased from 4% in 2012 to 15% over the TTM, while invested capital turns rose from 1.4 to 2.7 over the same time. Higher invested capital turns and NOPAT margins drive return on invested capital (ROIC) from 5% in 2012 to 26% in TTM.
Figure 1: Steel Dynamic’s Revenue & NOPAT Since 2012
Sources: New Constructs, LLC and company filings
Free Cash Flow Supports Regular Dividend Payments
Steel Dynamics has increased its regular dividend from $0.19/share in 1Q18 to $0.43/share in 3Q23. The current quarterly dividend, when annualized, equals $1.72/share and provides a 1.6% dividend yield.
More importantly, Steel Dynamics’ free cash flow (FCF) easily exceeds its regular dividend payments. From 2018 through 2Q23, Steel Dynamics generated $5.4 billion (27% of current enterprise value) in FCF while paying $1.2 billion in dividends. See Figure 2.
Figure 2: Steel Dynamics’ FCF vs. Regular Dividends Since 2018
Sources: New Constructs, LLC and company filings
Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.
STLD Is Undervalued
At its current price of $106/share, Steel Dynamics has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects Steel Dynamics’ NOPAT to permanently fall 50% from current levels. This expectation seems overly pessimistic given that Steel Dynamics has grown NOPAT by 26% compounded annually since 2012 and 20% compounded annually since 1998.
Even if Steel Dynamics’ NOPAT margin falls to 11% (average since 2016), and revenue falls by % compounded annually through 2032, the stock would be worth $135/share today – a 27% upside. See the math behind this reverse DCF scenario. In this scenario, Steel Dynamics’ NOPAT would decline 5% compounded annually through 2032. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.
Add in Steel Dynamics’ 1.6% dividend yield and a history of dividend growth, and it’s clear why this stock is in August’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 Steel Dynamics’ 10-K and 10-Qs:
Income Statement: we made $146 million in adjustments with a net effect of removing $104 million in non-operating expenses (1% of revenue). Clients can see all adjustments made to Steel Dynamics’ income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $2.2 billion in adjustments to calculate invested capital with a net decrease of $1.0 billion. The most notable adjustment was $534 million (4% of reported net assets) in asset write-downs. See all adjustments made to Steel Dynamics’ balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $4.8 billion in adjustments, with a net decrease in shareholder value of $2.6 billion. The most notable adjustment to shareholder value was $2.8 billion in total debt. This adjustment represents 16% of Steel Dynamics’ market value. See all adjustments to Steel Dynamics’ valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article was originally published on September 7, 2023.
Disclosure: David Trainer, Kyle Guske II, Italo Mendonça, and Hakan Salt receive no compensation to write about any specific stock, style, or theme.
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[1] 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.