Four new stocks made October’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of October 14, 2022.
Recap From September’s Picks
Our Exec Comp Aligned with ROIC Model Portfolio (-1.9%) outperformed the S&P 500 (-8.6%) from September 15, 2022 through October 12, 2022. The best performing stock in the portfolio was up 6%. Overall, 12 out of the 15 Exec Comp Aligned with ROIC stocks outperformed the S&P 500 from September 15, 2022 through October 12, 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. This combination provides a uniquely well-screened list of long ideas because the primary driver of shareholder value creation is return on invested capital (ROIC).
New Feature Stock for October: NVR Inc. (NVR: $4,000/share)
NVR Inc. (NVR) is the featured stock in October’s Exec Comp Aligned with ROIC Model Portfolio. We made NVR a Long Idea in April 2017. Since then, the stock is up 85% compared to a 57% gain for the S&P 500. See all of our reports on NVR here.
NVR has grown revenue and net operating profit after tax (NOPAT) by 13% and 26% compounded annually, respectively, since 2011. The company’s NOPAT margin rose from 5% in 2011 to 16% over the trailing-twelve-months (TTM), while invested capital turns rose from 2.3 to 3.3 over the same time. Rising NOPAT margins and invested capital turns drive ROIC from 12% in 2011 to 54% TTM.
Figure 1: NVR’s Revenue & NOPAT: 2011 – TTM
Sources: New Constructs, LLC and company filings
Executive Compensation Properly Aligns Executive Incentives
NVR’s executive compensation plan aligns executives’ interests with shareholders’ interests by tying the payout of equity awards to a three-year target return on capital, which is similar to our calculation of return on invested capital (ROIC).
The company’s inclusion of return on capital as a performance goal has helped create shareholder value through rising ROIC and economic earnings. NVR’s ROIC improved from 20% in 2016 to 54% over the TTM, and the company’s economic earnings rose from $308 million to $1.4 billion over the same period.
Figure 2: NVR’s ROIC: 2016 – TTM
Sources: New Constructs, LLC and company filings
NVR Is Undervalued
At its current price of ~$4,000/share, NVR has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects NVR’s NOPAT to permanently fall by 40%. This expectation seems overly pessimistic for a company that has grown NOPAT by 26% compounded annually over the past decade and 13% compounded annually over the past 20 years.
If NVR’s NOPAT margin falls to 12% (five-year average vs. 16% TTM), and the company grows revenue by just 3.5% compounded annually over the next 10 years, the stock would be worth ~$5,500/share today – a 38% 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 NVR’s 10-Qs and 10-Ks:
Income Statement: we made $57 million in adjustments, all of which were non-operating expenses (1% of revenue). Clients can see all adjustments made to NVR’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: we made $4.5 billion in adjustments to calculate invested capital with a net decrease of $350 million. One of the largest adjustments was $419 million (14% of reported net assets) in asset write-downs. Clients can see all adjustments made to NVR’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: we made $2.5 billion in adjustments with a net effect of decreasing shareholder value by $549 million. The most notable adjustment to shareholder value was $999 million in excess cash. This adjustment represents 8% of NVR’s market cap. Clients can see all adjustments to NVR’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on October 20, 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.