Nine stocks were added to our Dividend Growth Stocks Model Portfolio this month, which was made available to members on January 27, 2022.
Recap From December’s Picks
Overall, 26 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from December 29, 2021 through January 25, 2022. On a price return and total return basis, our Dividend Growth Stocks Model Portfolio (-2.1%) outperformed the S&P 500 (-9.0%) by 6.9%. The best performing stock was up 20%.
The methodology for 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 are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.
More reliable and proprietary fundamental data, proven in The Journal of Financial Economics, drives our research and provides investors with a new source of alpha. Our proprietary Robo-Analyst technology[1] scales our forensic accounting expertise (featured in Barron’s)[2] to produce an unrivaled database of fundamental data.
Featured Stock From January: Target Corporation (TGT: $218/share)
Target Corporation (TGT) is the featured stock from January’s Dividend Growth Stocks Model Portfolio. We made Target a Long Idea in June 2019. Since then, the stock is up 155% while the S&P 500 is up 94%. Even after its large outperformance, the stock still offers attractive risk/reward. See our most recent report on Target here.
Target has grown revenue by 3% compounded annually and net operating profit after-tax (NOPAT) by 6% compounded annually over the past decade. The firm’s NOPAT margin improved from 5% in fiscal 2011 (FYE is 1/30) to 7% over the trailing-twelve-month (TTM) period, while the firm’s invested capital turns improved from 2 to 3 over the same time. Rising NOPAT margin and invested capital turns drive return on invested capital (ROIC) from 9% in fiscal 2011 to 19% TTM.
Figure 1: Target’s NOPAT & Revenue Since Fiscal 2011
Sources: New Constructs, LLC and company filings
Target’s strong omnichannel operation benefited from accelerated ecommerce growth and the exit of weaker retailers during the COVID-19 pandemic. Going forward, Target is well positioned to grow revenue and profits from current levels. For reference, Target’s consensus revenue CAGR for fiscal 2022 – 2024 is 6.5%.
FCF Exceeds Dividends by Wide Margin
Target has increased its dividend for 50 consecutive years. The firm increased its regular dividend from $2.36/share in fiscal 2017 to $2.70/share in fiscal 2021, or 3% compounded annually. The current quarterly dividend, when annualized, equals $3.60/share and provides a 1.7% dividend yield.
More importantly, Target’s strong free cash flow (FCF) exceeds the firm’s growing dividend payments. Target’s cumulative $20.2 billion (19% of current market cap) in FCF is 3x the $6.7 billion in dividends paid out from fiscal 2017 – 2021, per Figure 2. Over the TTM, Target generated $5.4 billion in FCF and paid $1.5 billion in dividends. Figure 2 also shows that Target’s FCF significantly exceeded its dividend payments in each of the past five years.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Sources: New Constructs, LLC and company filings
Companies with FCF well above dividend payments provide higher quality dividend growth opportunities because we know the firm generates the cash to support a higher dividend. On the other hand, the dividend of a company where FCF falls short of the dividend payment over time cannot be trusted to grow or even maintain its dividend because of inadequate free cash flow.
Target Has Upside Potential
At its current price of $218/share, TGT has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means the market expects Target’s NOPAT to permanently decline by 30%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 6% compounded annually over the past two decades.
Even if Target’s NOPAT margins fall to 6% (vs. 7% TTM) and the firm grows NOPAT by just 3% compounded annually for the next decade, the stock is worth $310/share today – a 42% upside. See the math behind the reverse DCF scenario.
Should the firm grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Target’s 1.7% dividend yield and history of dividend growth, and it’s clear why this stock is in January’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 Target’s 10-Qs and 10-K:
Income Statement: we made $1.4 billion in adjustments with a net effect of removing $897 million in non-operating expenses (1% of revenue). See all adjustments made to Target’s income statement here.
Balance Sheet: we made $12.6 billion of adjustments to calculate invested capital with a net increase of $1.9 billion. The most notable adjustment was $4.1 billion (13% of reported net assets) in asset write-downs. See all adjustments to Target’s balance sheet here.
Valuation: we made $19.9 billion in adjustments with a net effect of decreasing shareholder value by $18.7 billion. Other than total debt, the most notable adjustment to shareholder value was $1.2 billion in net deferred tax liabilities. This adjustment represents 1% of Target’s market value. See all adjustments to Target’s valuation here.
This article originally published on February 3, 2022.
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 our research automation technology in the case Disrupting Fundamental Analysis with Robo-Analysts.
[2] See how our models and financial ratios are superior to Bloomberg and Capital IQ’s (SPGI) analytics in the detailed appendix of this paper.