Two new stocks make December’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of December 13, 2019.
Recap from November’s Picks
Our Exec Comp Aligned with ROIC Model Portfolio (+1.4%) outperformed the S&P 500 (+0.8%) from November 15, 2019 through December 11, 2019. The best performing stock in the portfolio was up 13%. Overall, eight out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P from November 15, 2019 through December 11, 2019.
Only our research utilizes the superior data and earnings adjustments featured by the HBS & MIT Sloan paper, "Core Earnings: New Data and Evidence.” The success of this Model Portfolio highlights the value of our Robo-Analyst technology[1], which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.
This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. We think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.[2]
New Stock Feature for December: NVR Inc. (NVR: $3,860/share)
NVR Inc. (NVR) is the featured stock in December’s Exec Comp Aligned with ROIC Model Portfolio.
We made NVR a Long Idea on 4/17/17, and reiterated the stock’s upside potential on 2/20/19. The stock has outperformed the S&P 500 since our original report (up 80% vs. S&P up 36%).
Over the past decade, NVR has grown revenue by 7% compounded annually and after-tax operating profit (NOPAT) by 13% compounded annually. Trailing twelve month (TTM) NOPAT is up 13% over the prior TTM period. Profit growth has been fueled by rising NOPAT margins, which are up from 6% in 2008 to 11% TTM.
Figure 1: NVR Revenue & NOPAT Growth Since 2008
Sources: New Constructs, LLC and company filings
Executive Compensation Plan Helps Drive Shareholder Value Creation
NVR has included return on capital as a performance metric in its executive compensation plan since 2014. Last year, 50% of long-term stock options were tied to the firm’s return on capital performance.
The focus on return on capital helps ensure intelligent capital allocation. Since adding return on capital to its compensation plan in 2014, NVR has improved its ROIC from 18% to 32% TTM. NVR’s executive compensation plan lowers the risk of investing in the company’s stock because we know executives’ interests are tied to shareholders’ interests.
Figure 2: NVR’s ROIC Since 2014
Sources: New Constructs, LLC and company filings
NVR Is Undervalued
At its current price of $3,860/share, NVR has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means the market expects NVR’s NOPAT to never meaningfully grow from current levels. This expectation seems pessimistic given that NVR has grown NOPAT by 13% compounded annually over the past decade and 12% compounded annually since 1998.
If NVR can maintain TTM NOPAT margins (11%) and grow NOPAT by just 5% compounded annually for the next decade, the stock is worth $5,161/share today – a 34% upside. See the math behind this reverse DCF scenario.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings as shown in the Harvard Business School and MIT Sloan paper, "Core Earnings: New Data and Evidence”.
Below are specifics on the adjustments we make based on Robo-Analyst findings in NVR’s 2018 10-K:
Income Statement: we made $133 million of adjustments, with a net effect of removing $55 million in non-operating income (1% of revenue). You can see all the adjustments made to NVR’s income statement here.
Balance Sheet: we made $1.9 billion of adjustments to calculate invested capital with a net increase of $539 million. One of the largest adjustments was $396 million due to asset write-downs. This adjustment represented 22% of reported net assets. You can see all the adjustments made to NVR’s balance sheet here.
Valuation: we made $3.0 billion of adjustments with a net effect of decreasing shareholder value by $1.6 billion. The largest adjustment to shareholder value was $1.6 billion in outstanding employee stock options. This adjustment represents 11% of NVR’s market cap. See all adjustments to NVR’s valuation here.
This article originally published on December 17, 2019.
Disclosure: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.
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[1] Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.
[2] This paper compares our analytics on a mega cap company to other major providers. The Appendix details exactly how we stack up.