Seven new stocks make our Dividend Growth Stocks Model Portfolio this month, which was made available to members on March 26, 2021.
Recap From February’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (+5.0%) outperformed the S&P 500 (+1.4%) by 3.6% from February 25, 2021 through March 24, 2021. On a total return basis, the Model Portfolio (+5.1%) outperformed the S&P 500 (+1.7%) by 3.4% over the same time. The best performing stock was up 20%. Overall, 23 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from February 25, 2021 through March 24, 2021.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research. Our proprietary Robo-Analyst technology[1] scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks[2] 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 March: Tractor Supply Co (TSCO: $177/share)
Tractor Supply Company (TSCO) is the featured stock from March’s Dividend Growth Stocks Model Portfolio.
Tractor Supply has grown revenue by 11% compounded annually and net operating profit after-tax (NOPAT) by 15% compounded annually over the past five years. The firm’s NOPAT margin increased from 7% in 2016 to 9% in 2020 while invested capital turns improved from 1.8 to 2.2 over the same time. Rising NOPAT margin and invested capital turns drive Tractor Supply’s return on invested capital (ROIC) higher from 13% in 2016 to 19% in 2020.
Figure 1: Tractor Supply NOPAT & Revenue Since 2016
Sources: New Constructs, LLC and company filings
Steady Dividend Growth Supported by FCF
Tractor Supply has increased its regular dividend in every year for the last decade from $0.28/share in 2010 to $1.50/share in 2020, or 18% compounded annually. The current quarterly dividend, when annualized, equals $2.08/share and provides a 1.2% dividend yield.
More importantly, Tractor Supply’s strong free cash flow (FCF) supports the firm’s growing dividend payments. Tractor Supply generated a cumulative $1.9 billion (9% of current market cap) in FCF while paying $741 million in dividends from 2016 to 2020, per Figure 2. In 2020, Tractor Supply Co generated $474 million in free cash flow and paid $175 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.
TSCO Has Upside Potential
At its current price of $177/share, TSCO has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects Tractor Supply’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 20% compounded annually over the past two decades.
Even if Tractor Supply’s NOPAT margin falls to its 5-year average of 8% (compared to 9% in 2020), and the firm grows NOPAT by just 3% compounded annually for the next decade, the stock is worth $251/share today – a 42% upside. See the math behind the reverse DCF scenario. Add in Tractor Supply Co’s 1.2% dividend yield and history of dividend growth, and it’s clear why this stock is in March’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
Fact: we provide superior fundamental data and earnings models – unrivaled in the world.
Proof: Core Earnings: New Data and Evidence, forthcoming in The Journal of Financial Economics.
Below are specifics on the adjustments we make based on Robo-Analyst findings in Tractor Supply’s 10-K:
Income Statement: we made $258 million in adjustments with a net effect of removing $166 million in non-operating expenses (2% of revenue). See all adjustments made to Tractor Supply Co’s income statement here.
Balance Sheet: we made $1.2 billion of adjustments to calculate invested capital with a net decrease of $1.1 billion. The most notable adjustment was $64 million (1% of reported net assets) in asset write-downs. See all adjustments to Tractor Supply Co’s balance sheet here.
Valuation: we made $4.4 billion of adjustments with a net effect of decreasing shareholder value by $2.8 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $811 million in excess cash. This adjustment represents 4% of Tractor Supply’s market value. See all adjustments to Tractor Supply Co’s valuation here.
This article originally published on March 31, 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.
[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.