Two new stocks make May’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of May 13, 2022.
Recap From April’s Picks
Our Exec Comp Aligned with ROIC Model Portfolio (-7.6%) outperformed the S&P 500 (-10.3%) from April 14, 2022, through May 11, 2022. The best performing stock in the portfolio was up 9%. Overall, nine out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P 500 from April 14, 2022, through May 11, 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 includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. We think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.
New Feature Stock for May: O’Reilly Automotive (ORLY: $600/share)
O’Reilly Automotive (ORLY) is the featured stock in May’s Exec Comp Aligned with ROIC Model Portfolio. We made ORLY a Long Idea on March 9, 2022. Since then, the stock is down 11% versus a 9% decline for the S&P 500.
O’Reilly has grown revenue and net operating profit after tax (NOPAT) by 9% and 15% compounded annually, respectively, over the past ten years. See Figure 1. The company’s NOPAT margin rose from 10% in 2011 to 17% over the trailing twelve months (TTM), while invested capital turns improved from 1.1 to 2.2 over the same time. Rising NOPAT margins and invested capital turns drive the company’s ROIC from 12% in 2011 to 38% TTM.
Figure 1: O’Reilly’s NOPAT & Revenue Growth: 2011 – TTM
Sources: New Constructs, LLC and company filings
Executive Compensation Properly Aligns Executive Incentives
O’Reilly’s executive compensation plan aligns the interests of management with those of shareholders by tying 20% of the annual cash bonus for executives to a target ROIC.
O’Reilly’s inclusion of ROIC as a performance goal has helped create shareholder value through rising ROIC and economic earnings. O’Reilly’s ROIC improved from 24% in 2017 to 38% TTM and the company’s economic earnings nearly doubled from $1.1 billion to $2.0 billion over the same period.
Figure 2: O’Reilly’s ROIC: 2017 – TTM
Sources: New Constructs, LLC and company filings
O’Reilly Is Undervalued
At its current price of $600/share, ORLY has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means the market does not expect O’Reilly’s NOPAT to meaningfully grow above TTM levels. This expectation seems overly pessimistic for a company that has grown NOPAT by 20% compounded annually over the past two decades.
If O’Reilly maintains TTM NOPAT margins of 17% and the company grows NOPAT by 6% compounded annually over the next 10 years, the stock is worth $1,000/share today – a 67% 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 O’Reilly’s 10-Q’s and 10-K:
Income Statement: we made $315 million in adjustments, with a net effect of removing $179 million in non-operating expenses (1% of revenue). Clients can see all adjustments made to O’Reilly’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $356 million in adjustments to calculate invested capital with a net decrease of $13 million. One of the largest adjustments was $36 million (1% of reported net assets) in operating leases. Clients can see all adjustments made to O’Reilly’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $6.4 billion in adjustments all of which decrease shareholder value. Apart from total debt, the most notable adjustment to shareholder value was $308 million in outstanding employee stock options (ESO). This adjustment represents 1% of O’Reilly’s market cap. Clients can see all adjustments to O’Reilly’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on May 19, 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.