Five new stocks make February’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of February 14, 2020.
Recap from January’s Picks
Our Exec Comp Aligned with ROIC Model Portfolio (-4.2%) underperformed the S&P 500 (+2.8%) from January 15, 2020 through February 12, 2020. The best performing stock in the portfolio was up 8%. Overall, one out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P from January 15, 2020 through February 12, 2020, and five had positive returns.
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 February: SYSCO Corporation (SYY: $78/share)
SYSCO Corporation (SYY) is the featured stock in February’s Exec Comp Aligned with ROIC Model Portfolio.
We made SYY a Long Idea on December 13, 2017. Since then, the stock is up 27% (vs. S&P 500 up 27%) and remains undervalued.
Over the past five years, SYY has grown revenue by 5% 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 as well. Rising NOPAT margins, which are up from 2% in 2015 to 3% in 2019 have fueled SYY’s profit growth.
Figure 1: SYY Revenue & NOPAT Growth Since 2015
Sources: New Constructs, LLC and company filings
Executive Compensation Plan Helps Drive Shareholder Value Creation
SYY has included ROIC as a performance metric in its executive compensation plan since 2012. Last year, 33% of performance stock awards were tied to the firm’s ROIC performance. When combined with stock options, annual incentives, and salaries, ROIC was tied to ~12-14% of total executive compensation.
The focus on ROIC helps ensure intelligent capital allocation. Per Figure 2, SYY has improved its ROIC from 10% in 2015 to 14% TTM. SYY’s compensation plan lowers the risk of investing in the company’s stock because we know executives’ interests are aligned with shareholders’ interests.
Figure 2: SYY’s ROIC Since 2015
Sources: New Constructs, LLC and company filings
SYY is Undervalued
At its current price of $78/share, SYY has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means the market expects SYY’s NOPAT to never meaningfully grow from current levels. This expectation seems pessimistic given that SYY has grown NOPAT by 13% compounded annually over the past five years and 9% compounded annually over the past two decades.
If SYY can maintain TTM NOPAT margins (3%) and grow NOPAT by just 4% compounded annually for the next decade, the stock is worth $103/share today – a 32% 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 SYSCO Corporation’s 2019 10-K:
Income Statement: we made $1.1 billion of adjustments, with a net effect of removing $382 million in non-operating expenses (<1% of revenue). You can see all the adjustments made to SYY’s income statement here.
Balance Sheet: we made $2.7 billion of adjustments to calculate invested capital with a net increase of $2.6 billion. One of the largest adjustments was $1.6 billion related to other comprehensive income. This adjustment represented 14% of reported net assets. You can see all the adjustments made to SYY’s balance sheet here.
Valuation: we made $10.9 billion of adjustments with a net effect of decreasing shareholder value by $10.9 billion. There were no adjustments that increased shareholder value. Apart from total debt, one of the largest adjustments to shareholder value was $695 million in underfunded pensions. This adjustment represents 2% of SYY’s market cap. See all adjustments to SYY’s valuation here.
This article originally published on February 18, 2020.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler 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 Bloomberg and Capital IQ (SPGI) in a detailed appendix.