Six new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on June 23, 2022.
Recap from May’s Picks
On a price return basis, our Safest Dividend Yields Model Portfolio (-6.6%) underperformed the S&P 500 (-3.7%) by 2.9% from May 19, 2022 through June 21, 2022. On a total return basis, the Model Portfolio (-5.9%) underperformed the S&P 500 (-3.3%) by 2.6% over the same time. The best performing large cap stock was up 7% and the best performing small cap stock was up 4%. Overall, eight out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from May 19, 2022 through June 21, 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 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 June: United Parcel Service, Inc. (UPS: $180/share)
United Parcel Service, Inc. (UPS) is the featured stock in June’s Safest Dividend Yields Model Portfolio.
United Parcel Service has grown revenue by 6% compounded annually and net operating profit after-tax (NOPAT) by 9% compounded annually since 2011. United Parcel Service’s NOPAT margin rose from 8% in 2011 to 11% over the trailing twelve months (TTM), while invested capital turns improved from 1.6 to 1.9 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 13% in 2011 to 20% TTM.
Figure 1: UPS’ Revenue and NOPAT Since 2011
Sources: New Constructs, LLC and company filings
Free Cash Flow Supports Regular Dividend Payments
United Parcel Service has paid dividends in each year since 1999 and increased its regular dividend from $3.32/share in 2017 to $4.08/share in 2021. The current quarterly dividend, when annualized, provides a 3.4% dividend yield.
United Parcel Service’s cumulative FCF exceeds its regular dividend payments. From 2017 to 2021, UPS generated $17.9 billion (11% of current market cap) in FCF while paying $15.8 billion in dividends, per Figure 2. Over the TTM, UPS has generated $7.9 billion in FCF and paid $3.9 billion in dividends.
Should the economic slowdown in 2022 worsen, and the company’s FCF turn negative as it did in 2007 and 2017, the company's $12.5 billion of cash and cash equivalents provide an extra layer of protection for the dividend.
Figure 2: UPS’ FCF vs. Regular Dividends Since 2017
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.
UPS Is Undervalued
At its current price of $180/share, UPS has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects United Parcel Service’s NOPAT to permanently decline by 20%. This expectation seems overly pessimistic given that United Parcel Service grew NOPAT by 9% compounded annually over the past decade and 15% compounded annually over the past five years.
Even if United Parcel Service’s NOPAT margin falls to 9% (three-year average vs. 11% over the TTM) and the company’s NOPAT grows just 2% compounded annually over the next decade, the stock is worth $225/share today – a 25% upside. See the math behind this reverse DCF scenario. 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 make based on Robo-Analyst findings in United Parcel Service’s 10-K and 10-Qs:
Income Statement: we made $6.5 billion in adjustments with a net effect of removing $2.9 million in non-operating income (3% of revenue). Clients can see all adjustments made to United Parcel Service’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $13.6 billion in adjustments to calculate invested capital with a net increase of $1.2 billion. The most notable adjustment was $3.3 billion (6% of reported net assets) in other comprehensive income. See all adjustments made to United Parcel Service’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $45.7 billion in adjustments with a net effect of decreasing shareholder value by $30.5 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $7.9 billion in underfunded pensions. This adjustment represents 5% of United Parcel Service’s market value. See all adjustments to United Parcel Service’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on June 30, 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] 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.