Three new stocks made February’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of February 16, 2023.
Recap From January’s Picks
Our Exec Comp Aligned with ROIC Model Portfolio (+4.6%) outperformed the S&P 500 (+3.5%) from January 13, 2023 through February 14, 2023. The best-performing stock in the portfolio was up 16%. Overall, 9 out 15 Exec Comp Aligned with ROIC stocks outperformed the S&P 500 from January 13, 2023 through February 14, 2023.
This Model Portfolio includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. This combination provides a unique list of long ideas as the primary driver of shareholder value creation is return on invested capital (ROIC).
New Feature Stock for February: O’Reilly Automotive Inc (ORLY: $841/share)
O’Reilly Automotive Inc (ORLY) is the featured stock in February’s Exec Comp Aligned with ROIC Model Portfolio. We originally made O’Reilly a Long Idea in March 2022. Since then, the stock is up 27% compared to a 7% decline for the S&P 500. The stock remains undervalued, as we highlighted in our recent report here. Get all of our reports on O’Reilly here.
O’Reilly has grown revenue and NOPAT by 10% and 12% compounded annually, respectively, since 2017. The company’s NOPAT margin rose from 13% in 2016 to 17% over the trailing-twelve-months (TTM), while invested capital turns rose from 1.6 to 2.4 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 21% in 2016 to 40% in the TTM.
Figure 1: O’Reilly’s Revenue & NOPAT: 2012 – TTM
Sources: New Constructs, LLC and company filings
Executive Compensation Properly Aligns Incentives
O’Reilly’s executive compensation plan aligns the interests of executives and shareholders by tying the payout of incentive compensation to specific performance metrics, which include return on invested capital and free cash flow.
The company’s inclusion of ROIC as a performance goal has helped create shareholder value through rising ROIC and economic earnings. O’Reilly’s ROIC has increased from 10% in 2010 to 40% over the TTM, while economic earnings rose from $237 million to $2.0 billion over the same time.
Figure 2: O’Reilly’s ROIC: 2010 – TTM
Sources: New Constructs, LLC and company filings
ORLY Has Further Upside
At the current price of $841/share, ORLY has a price-to-economic book value (PEBV) ratio of 1.9. Though the company’s PEBV ratio is higher than other Long Ideas, we believe O’Reilly’s competitive moat positions it for further growth and the stock still holds upside potential.
If O’Reilly maintains its five-year average NOPAT margin of 16%, and the company grows revenue by 11% compounded annually (its three-year compound annual growth rate) from 2022 – 2031, the stock would be worth $1,091/share today – a 30% upside. In this scenario, O’Reilly’s NOPAT would grow 10% compounded annually over the next decade. See the math behind this reverse DCF scenario.
For reference, O’Reilly has had compound annual NOPAT growth of 15% over the last ten years. Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Below are specifics on the adjustments we made based on Robo-Analyst findings in O’Reilly’s 10-Qs and 10-Ks:
Income Statement: we made $315 million in adjustments with a net effect of removing $179 million in non-operating expenses (1% of revenue). Clients can see all adjustments made to O’Reilly’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $356 million in adjustments to calculate invested capital with a net decrease of $13 million. One of the largest adjustments was $36 million (1% of reported net assets) in adjustments for operating leases. Clients can see all adjustments made to O’Reilly’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $6.6 billion in adjustments, all of which decrease shareholder value. Apart from total debt, the most notable adjustment to shareholder value was $476 million in outstanding employee stock options. This adjustment represents 1% of O’Reilly’s market cap. Clients can see all adjustments to O’Reilly’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article was originally published on February 24, 2023.
Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça 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.