Eleven new stocks made February’s Dividend Growth Stocks Model Portfolio, which was made available to members on February 28, 2023.

Recap from February’s Picks

On a price return basis, our Dividend Growth Stocks Model Portfolio (-1.7%) outperformed the S&P 500 (-2.2%) by 0.5% from January 27, 2023 through February 24, 2023. On a total return basis, the Model Portfolio (-1.5%) outperformed the S&P 500 (-2.2%) by 0.7% over the same time. The best performing stock was up 15%. Overall, 19 out of 30 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from January 27, 2023 through February 24, 2023.

Buy the Dividend Growth Stocks Model Portfolio

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 February: Williams-Sonoma, Inc (WSM: $124/share)

Williams-Sonoma, Inc (WSM) is the featured stock in February’s Dividend Growth Stocks Model Portfolio. We first made Williams-Sonoma a Long Idea in September 2016 and the stock has outperformed the S&P 500 by 83% since then. See our most recent report on WSM here.

Williams Sonoma has grown revenue by 10% compounded annually and net operating profit after tax (NOPAT) by a whopping 27% compounded annually from fiscal 2017 to fiscal 2022. The company’s NOPAT margin has doubled from 7% in fiscal 2017 to 14% over the trailing-twelve-months (TTM), while invested capital turns improved from 1.8 to 2.6 over the same time. Rising NOPAT margins and invested capital turns drive return on invested capital (ROIC) from 12% in fiscal 2017 to 37% in the TTM.

Figure 1: Williams Sonoma’s Revenue & NOPAT Since Fiscal 2013

Williams-Sonoma Revenue & NOPAT Since 2013

Sources: New Constructs, LLC and company filings

Free Cash Flow Supports Regular Dividend Payments

Williams Sonoma has increased its regular dividend from $1.56/share in fiscal 2017 to $2.60/share in fiscal 2022, or 11% compounded annually. The current quarterly dividend when annualized equals $3.12/share and provides a 2.5% dividend yield.

More importantly, Williams Sonoma’s free cash flow (FCF) easily exceeds its regular dividend payments. From fiscal 2019 through the nine months ended fiscal 3Q23 (October 2022), Williams Sonoma generated $3.5 billion (36% of current enterprise value) in FCF while paying $855 million in dividends. Over the TTM, Williams Sonoma generated $1.2 billion in FCF and paid out $218 million in dividends. See Figure 2.

Figure 2: Williams Sonoma’s FCF vs. Regular Dividends Since Fiscal 2019

Williams-Sonoma FCF vs. Dividends

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.

WSM Is Undervalued

At its current price of $124/share, Williams Sonoma has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects Williams Sonoma’s NOPAT to fall 40% permanently. This expectation seems overly pessimistic given that Williams Sonoma has grown NOPAT by 27% compounded annually since fiscal 2017 and 16% compounded annually since fiscal 2012.

Even if Williams Sonoma’s NOPAT margin falls to 9% (below its TTM NOPAT margin of 14%) and revenue grows by just 5% compounded annually (below 8% compounded annually since fiscal 2012) over the next decade, the stock would be worth $161/share today – a 30% upside. In this scenario, Williams Sonoma’s NOPAT would not grow at all through 2032. For reference, NOPAT is up 15% over the TTM. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.

Add in Williams Sonoma’s 2.5% dividend yield and a history of dividend growth, and it’s clear why this stock is in February’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 Williams Sonoma’s 10-Ks and 10-Qs:

Income Statement: we made $114 million in adjustments with a net effect of removing $62 million in non-operating expenses (<1% of revenue). Clients can see all adjustments made to Williams Sonoma’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.

Balance Sheet: we made $1.4 billion in adjustments to calculate invested capital with a net increase of $41 million. The most notable adjustment was $559 million (20% of reported net assets) in operating leases. See all adjustments made to Williams Sonoma’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.

Valuation: we made $1.6 billion in adjustments, with a net decrease of $1.6 billion in shareholder value. Apart from total debt, one of the most notable adjustments to shareholder value was $177 million in operating leases. This adjustment represents 2% of Williams Sonoma’s market value. See all adjustments to Williams Sonoma’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.

This article was originally published on March 10, 2023.

Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça 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.

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