Eight new stocks make our Dividend Growth Stocks Model Portfolio this month, which was made available to members on July 29, 2021.
Recap From June’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (+0.1%) underperformed the S&P 500 (+2.6%) by 2.5% from June 30, 2021 through July 27, 2021. On a total return basis, the Model Portfolio (+0.2%) underperformed the S&P 500 (+2.6%) by 2.4% over the same time. The best performing stock was up 9%. Overall, nine out of the 30 Dividend Growth Stocks outperformed the S&P 500 from June 30, 2021 through July 27, 2021.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research. Our proprietary Robo-Analyst technology scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks to produce an unrivaled database of fundamental data.
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.
Featured Stock From July: The Travelers Companies Inc. (TRV: $150/share)
The Travelers Companies Inc. (TRV) is the featured stock from July’s Dividend Growth Stocks Model Portfolio.
The Travelers Companies has grown revenue by 3% compounded annually and net operating profit after-tax (NOPAT) by 5% compounded annually since 2017. Longer term, the firm has grown NOPAT by 6% compounded annually since 2004. The firm’s return on invested capital (ROIC) rose from 8% in 2017 to 11% over the trailing twelve months (TTM).
Figure 1: The Travelers Companies’ NOPAT & Revenue Since 2017
Sources: New Constructs, LLC and company filings
Steady Dividend Growth Supported by FCF
The Travelers Companies has increased its regular dividend in every year for the last 15 years and from $1.16/share in 2004 to $3.37/share in 2020, or 7% compounded annually. The current quarterly dividend, when annualized, equals $3.52/share and provides a 2.3% dividend yield.
More importantly, The Travelers Companies’ strong free cash flow (FCF) supports the firm’s growing dividend payments. The Travelers Companies generated a cumulative $8.7 billion (23% of current market cap) in FCF while paying $4.1 billion in dividends from 2016 to 2020, per Figure 2. In the TTM period, The Travelers Companies generated $1.1 billion in FCF and paid $871 million in dividends.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Sources: New Constructs, LLC and company filings
Companies with FCF well in excess of 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.
TRV Has Upside Potential
At its current price of $150/share, TRV has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects The Travelers Companies’ NOPAT to permanently decline by 50%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 6% compounded annually since 2004.
Even if The Travelers Companies’ NOPAT margin falls to 8% (below 10-year average of 10% and compared to 11% TTM) and the firm’s NOPAT grows by just 4% compounded annually for the next decade, the stock is worth $258/share today – a 72% 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 The Travelers Companies’ 2.3% dividend yield and history of dividend growth, and it’s clear why this stock is in July’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 The Travelers Companies’ 10-K and 10-Qs:
Income Statement: we made $553 million in adjustments with a net effect of removing $17 million in non-operating expenses (>1% of revenue). See all adjustments made to The Travelers Companies’ income statement here.
Balance Sheet: we made $3.8 billion of adjustments to calculate invested capital with a net decrease of $3.1 billion. The most notable adjustment was $2.5 billion (7% of reported net assets) in other comprehensive income. See all adjustments to The Travelers Companies’ balance sheet here.
Valuation: we made $1.0 billion in adjustments, all of which decreased shareholder value. The most notable adjustment to shareholder value was $415 million in deferred tax liabilities. This adjustment represents 1% of The Travelers Companies’ market value. See all adjustments to The Travelers Companies’ valuation here.
This article originally published on August 5, 2021.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.Follow us on Twitter, Facebook, LinkedIn, and StockTwits for real-time alerts on all our research.
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