Three new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on October 21, 2021.
Recap from September’s Picks
On a price return basis, our Safest Dividend Yields Model Portfolio (+2.9%) outperformed the S&P 500 (+1.7%) by 1.2% from September 23, 2021 through October 19, 2021. On a total return basis, the Model Portfolio (+3.1%) outperformed the S&P 500 (+1.7%) by 1.4% over the same time. The best performing large cap stock was up 7% and the best performing small cap stock was up 13%. Overall, 14 out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from September 23, 2021 through October 19, 2021.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research and provides investors with a new source of alpha. Our proprietary Robo-Analyst technology scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks to produce an unrivaled database of fundamental data.
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 October: Walgreens Boots Alliance Inc. (WBA: $47/share)
Walgreens (WBA) is the featured stock in October’s Safest Dividend Yields Model Portfolio.
Prior to the COVID-19 pandemic, Walgreens Boots Alliance grew revenue and net operating profit after-tax (NOPAT) by 8% compounded annually from fiscal 2011 to fiscal 2019 (year ended August 31, 2019). Since then, NOPAT has yet to recover, as NOPAT margins of 2.5% in fiscal 2021 are down from 4.7% in fiscal 2019.
Figure 1: Walgreens Boots Alliance’s Revenue & NOPAT Since Fiscal 2011
Sources: New Constructs, LLC and company filings
Free Cash Flow Exceeds Dividend Payments
Despite no clear rebound in profits, Walgreens Boots Alliance’s business continues to generate significant free cash flow (FCF) to support its dividend payment. Walgreens Boots Alliance has paid quarterly dividends every quarter since 1933 and increased its regular dividend from $1.53/share in fiscal 2017 to $1.88/share in fiscal 2021. The current regular quarterly dividend, when annualized, provides a 4.1% dividend yield.
Since fiscal 2017, Walgreens Boots Alliance’s cumulative FCF easily exceeds its regular dividend payments. From fiscal 2017 to fiscal 2021, Walgreens Boots Alliance generated $37.9 billion (93% of current market cap) in FCF while paying $8.5 billion in dividends, per Figure 2.
Figure 2: Walgreens Boots Alliance’s FCF vs. Standard Dividends Since Fiscal 2017
Sources: New Constructs, LLC and company filings
Companies with strong FCF provide higher quality dividend yields because we know the firm has the cash to support its dividend. On the other hand, dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.
WBA Is Undervalued
At its current price of $47/share, Walgreens Boots Alliance has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects Walgreens Boots Alliance’s NOPAT to permanently decline by 40%. This expectation seems overly pessimistic given that, even when accounting for the drop in profitability over the past two years, Walgreens Boots Alliance has grown NOPAT by 5% compounded annually over the past two decades.
Even if Walgreens Boots Alliance maintains its fiscal 2021 NOPAT margin of 2.5% (lowest ever vs. 4.5% 10-year average NOPAT margin) and the company’s NOPAT grows by just 2% compounded annually over the next decade, the stock is worth $85/share today – a 81% upside. See the math behind this reverse DCF scenario. Should the company grow NOPAT more in line with pre-pandemic 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 Walgreens Boots Alliance’s 10-K:
Income Statement: we made $5.9 billion in adjustments with a net effect of removing $662 million in non-operating expenses (<1% of revenue). See all adjustments made to Walgreens’ income statement here.
Balance Sheet: we made $17.3 billion in adjustments to calculate invested capital with a net increase of 12.7 billion. The most notable adjustment was $3.6 billion (6% of reported net assets) in deferred tax assets. See all adjustments Walgreens’ balance sheet here.
Valuation: we made $38.2 billion of adjustments to shareholder value, with a net decrease of $38.0 billion to shareholder value. Apart from total debt, one of the most notable adjustments to shareholder value was $1.8 billion in deferred tax liabilities. This adjustment represents 4% of Walgreens’ market value. See all adjustments to Walgreen’s valuation here.
This article originally published on October 29, 2021.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
 Harvard Business School features our research automation technology in the case Disrupting Fundamental Analysis with Robo-Analysts.