Thirteen new stocks made March’s Dividend Growth Stocks Model Portfolio, which was made available to members on March 29, 2023.

Recap from February’s Picks

On a price return basis, our Dividend Growth Stocks Model Portfolio (-4.7%) underperformed the S&P 500 (+0.1%) by 4.8% from February 28, 2023 through March 27, 2023. On a total return basis, the Model Portfolio (-4.5%) underperformed the S&P 500 (+0.4%) by 4.9% over the same time. The best performing stock was up 5%. Overall, nine out of 30 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from February 28, 2023 through March 27, 2023.

Buy the Dividend Growth Stocks Model Portfolio

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 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 favor long-term capital appreciation over current income, but still appreciate the power of growing dividends.

Featured Stock for February: Snap-On Inc. (SNA: $237/share)

Snap-On (SNA) is the featured stock in March’s Dividend Growth Stocks Model Portfolio. We first made Snap-On a Long Idea in February 2018 and the stock is up 51% while the S&P 500 is up 52% since then.

Snap-On has grown revenue by 5% compounded annually and net operating profit after tax (NOPAT) by 9% compounded annually over the past decade. The company’s NOPAT margin has increased from 12% in 2012 to 19% in 2022. Even though invested capital turns fell slightly during that period, NOPAT margins increased enough to drive return on invested capital (ROIC) from 11% in 2012 to 16% in 2022.

Figure 1: Snap-On’s Revenue & NOPAT Since 2012

Sources: New Constructs, LLC and company filings

Free Cash Flow Supports Regular Dividend Payments

Snap-On has increased its regular dividend from $3.41/share in 2018 to $5.88/share in 2022, or 15% compounded annually. The current quarterly dividend, when annualized, equals $6.48/share and provides a 2.7% dividend yield.

More importantly, Snap-On’s free cash flow (FCF) easily exceeds its regular dividend payments. From 2018 through 2022, Snap-On generated $2.9 billion (22% of current enterprise value) in FCF while paying $1.2 billion in dividends. See Figure 2.

Figure 2: Snap-On’s FCF vs. Regular Dividends Since 2018

Sources: New Constructs, LLC and company filings

Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.

SNA Is Undervalued

At its current price of $237/share, Snap-On has a price-to-economic book value (PEBV) ratio of 1.1. This ratio means the market expects Snap-On’s NOPAT to increase just 10% from 2022 levels over the life of the company. This expectation seems overly pessimistic given that Snap-On has grown NOPAT by 9% compounded annually over the past decade and 12% compounded annually over the past two decades.

Even if Snap-On maintains its 2022 NOPAT margin of 19% and grows revenue by just 4% compounded annually over the next decade, the stock would be worth $285/share today – a 20% upside. In this scenario, Snap-On’s NOPAT would grow just 4% compounded annually through 2032. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.

Add in Snap-On’s 2.7% dividend yield and a 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

Below are specifics on the adjustments we make based on Robo-Analyst findings in Snap-On’s 10-K:

Income Statement: we made $134 million in adjustments with a net effect of removing $26 million in non-operating expenses (<1% of revenue). Clients can see all adjustments made to Snap-On’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.

Balance Sheet: we made $1.8 billion in adjustments to calculate invested capital with a net decrease of $168 million. The most notable adjustment was $528 million (9% of reported net assets) in other comprehensive income. See all adjustments made to Snap-On’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.

Valuation: we made $1.9 billion in adjustments, with a net decrease of $605 million in shareholder value. Apart from total debt, one of the most notable adjustments to shareholder value was $660 million in excess cash. This adjustment represents 5% of Snap-On’s market value. See all adjustments to Snap-On’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.

This article was originally published on April 5, 2023.

Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça 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.

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