11 new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on February 21, 2019.

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This Model Portfolio leverages our Robo-Analyst technology[1], which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.[2]

This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because we know they have the cash to support the dividend. We think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.

Featured Stock for February: Omnicom Group (OMC: $76/share)

Omnicom Group (OMC) is the featured stock in February’s Safest Dividend Yield Model Portfolio. We also featured OMC as a Long Idea in May 2018.

Since 2013, OMC has grown after-tax operating profit (NOPAT) by 3% compounded annually. NOPAT margin has increased from 9% in 2013 to 10% in 2018 and return on invested capital (ROIC) has improved from 12% to 14% over the same time.

Figure 1: OMC Profitability Since 2013

Sources: New Constructs, LLC and company filings

OMC’s Free Cash Flow Supports Dividend Payments

Since 2014, OMC has increased its annual dividend from $1.90/share to $2.40/share, or 6% compounded annually. This increase in dividend payments has been supported by OMC’s free cash flow. From 2014-2018, OMC generated a cumulative $6.6 billion (39% of market cap) in FCF while paying $2.5 billion in dividends.

Companies with strong free cash flow provide higher quality dividend yields because we know the firm has the cash to support its dividend. On the flip side, dividends from companies with low or negative free cash flow cannot be trusted as much because the company may not be able to sustain paying dividends.

Figure 2: OMC’s FCF vs. Dividends Since 2014

Sources: New Constructs, LLC and company filings

Valuation Implies Permanent Profit Decline

At its current price of $76/share, OMC has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means the market expects OMC’s NOPAT to permanently decline by 30%. This expectation seems pessimistic given that OMC has grown NOPAT by 7% compounded annually over the past two decades.

If OMC can maintain 2018 NOPAT margins (10%) and grow NOPAT by just 3% compounded annually for the next decade, the stock is worth $122/share today – a 61% upside. See the math behind this dynamic 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. Below are specifics on the adjustments we make based on Robo-Analyst findings in Omnicom Group’s 2018 10-K:

Income Statement: we made $998 million of adjustments with a net effect of removing $212 million in non-operating expense (1% of revenue). See all adjustments made to OMC’s income statement here.

Balance Sheet: we made $7.8 billion of adjustments to calculate invested capital with a net increase of $1.7 billion. The most notable adjustment was $1.5 billion (16% of reported net assets) related to off-balance sheet operating leases. See all adjustments to OMC’s balance sheet here.

Valuation: we made $10.8 billion of adjustments with a net effect of decreasing shareholder value by $5 billion. Apart from $6.4 billion in total debt, which includes the operating leases noted above, the largest adjustment to shareholder value was $2.9 billon in excess cash. This adjustment represents 17% of OMC’s market value.

This article originally published on February 28, 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] Ernst & Young’s recent white paper “Getting ROIC Right” demonstrates the superiority of our stock research and analytics.

Click here to download a PDF of this report.

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