Four new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on July 21, 2022.
Recap from June’s Picks
On a price return basis, our Safest Dividend Yields Model Portfolio (+4.4%) outperformed the S&P 500 (+3.8%) by 0.6% from June 23, 2022 through July 19, 2022. On a total return basis, the Model Portfolio (+4.8%) outperformed the S&P 500 (+3.8%) by 1.0% over the same time. The best performing large cap stock was up 12% and the best performing small cap stock was up 14%. Overall, nine out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from June 23, 2022 through July 19, 2022.
This report leverages our cutting-edge Robo-Analyst technology to deliver proven-superior[1] fundamental research and support more cost-effective fulfillment of the fiduciary duty of care.
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 (FCF) 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 July: Dow Inc (DOW: $52/share)
Dow Inc (DOW) is the featured stock in July’s Safest Dividend Yields Model Portfolio.
Since its spin-off from Dupont De Nemours Inc. (DD) in 2019, Dow has grown revenue by 13% compounded annually and net operating profit after-tax (NOPAT) by 65% compounded annually. Dow’s NOPAT margin rose from 6% in 2019 to 13% over the trailing twelve months (TTM), while invested capital turns improved from 0.7 to 1.1 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 4% in 2019 to 14% TTM.
Figure 1: Dow’s Revenue and NOPAT Since 2019
Sources: New Constructs, LLC and company filings
Free Cash Flow Supports Regular Dividend Payments
Dow has increased its regular dividend from $2.10/share in 2019 to $2.80/share in 2021. The current quarterly dividend, when annualized, provides a 5.5% dividend yield.
Dow’s free cash flow (FCF) comfortably exceeds its regular dividend payments. From 2019 to 2021, Dow generated $16.0 billion (43% of current market cap) in FCF while paying $5.7 billion in dividends. Over the TTM, Dow has generated $6 billion in FCF and paid $2 billion in dividends. See Figure 2.
Figure 2: Dow’s FCF vs. Regular Dividends Since 2019
Sources: New Constructs, LLC and company filings
Companies with strong FCF provide higher quality dividend yields because the firm has the cash to support its dividend. Dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.
DOW Is Undervalued
At its current price of $52/share, DOW has a price-to-economic book value (PEBV) ratio of 0.3. This ratio means the market expects Dow’s NOPAT to permanently decline by 70%. This expectation seems overly pessimistic given that Dow grew NOPAT by 65% compounded annually since 2019.
Even if Dow’s NOPAT margin falls to 9% (vs. 13% over the TTM) and the company’s NOPAT falls 5% compounded annually over the next decade, the stock would be worth $75+/share today – a 44% upside. See the math behind this reverse DCF scenario. Should the company’s NOPAT not fall at such a steep rate, or even grow from current levels, the stock has even more upside.
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 Dow’s 10-K and 10-Qs:
Income Statement: we made $3.1 billion in adjustments with a net effect of removing $930 million in non-operating expenses (2% of revenue). Clients can see all adjustments made to Dow’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $16.6 billion in adjustments to calculate invested capital with a net increase of $11.3 billion. The most notable adjustment was $9.0 billion (18% of reported net assets) in other comprehensive income. See all adjustments made to Dow’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $24.1 billion in adjustments with a net effect of decreasing shareholder value by $19.8 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $6.1 billion in underfunded pensions. This adjustment represents 16% of Dow’s market value. See all adjustments to Dow’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on July 29, 2022.
Disclosure: David Trainer, Kyle Guske II, Matt Shuler, and Brian Pellegrini receive no compensation to write about any specific stock, style, or theme.
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[1] 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.