Seven new stocks make our Dividend Growth Stocks Model Portfolio this month, which was made available to members on September 30, 2020.
Recap from August’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (-2.6%) outperformed the S&P 500 (-4.1%) by 1.5% from August 27, 2020 through September 28, 2020. On a total return basis, the Model Portfolio (-2.3%) outperformed the S&P 500 (-3.7%) by 1.4% over the same time. The best performing stock was up 6%. Overall, 20 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from August 27, 2020 through September 28, 2020.
Only our research utilizes the superior data and earnings adjustments featured by the HBS & MIT Sloan paper, "Core Earnings: New Data and Evidence.” The long-term success of our model portfolio strategies highlights the value of our Robo-Analyst technology, which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.
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 September: The J.M. Smucker Company (SJM: $117/share)
The J.M. Smucker Company (SJM) is the featured stock from September’s Dividend Growth Stocks Model Portfolio.
J.M. Smucker has grown revenue and net operating profit after-tax (NOPAT) by 5% compounded annually over the past decade. Over the past three years, J.M. Smucker has grown NOPAT by 4% compounded annually. The firm’s NOPAT margin has increased from 12% in fiscal year ended (FYE) 2017 to 13% TTM, while return on invested capital (ROIC) has improved from 5.5% to 6.3% over the same time.
Figure 1: J.M. Smucker’s Revenue & NOPAT Since 2017
Sources: New Constructs, LLC and company filings
Steady Dividend Growth Supported by FCF
J.M. Smucker has increased its dividend for 19 consecutive years and from $2.68/share in FYE 2016 to $3.52/share in FYE 2020, or 7% compounded annually. The current quarterly dividend, when annualized, equals $3.60/share and provides a 3.1% dividend yield.
More importantly, J.M. Smucker’s strong free cash flow (FCF) supports the firm’s dividend payment. J.M. Smucker generated $4.4 billion (33% of current market cap) in FCF while paying $1.8 billion in dividends from FYE 2016 to FYE 2020, per Figure 2. Over the TTM, J.M. Smucker generated $923 million in FCF and paid just $400 million in dividends.
Figure 2: Free Cash Flow (FCF) 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.
SJM Has Upside Potential
At its current price of $117/share, SJM has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects J.M. Smucker’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that J.M. Smucker grew NOPAT by 11% compounded annually over the past five years and 5% compounded annually over the past decade.
Even if J.M. Smucker’s NOPAT margin falls to 10% (10-year low vs. 13% TTM) and the firm grows NOPAT by less than 1% compounded annually for the next decade, the stock is worth $224/share today – a 91% upside. See the math behind this reverse DCF scenario.
Critical Details Found in Financial Filings by Our Robo-Analyst Technology
As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings as shown in the Harvard Business School and MIT Sloan paper,"Core Earnings: New Data and Evidence”.
Below are specifics on the adjustments we make based on Robo-Analyst findings in J.M. Smucker’s FYE 2020 10-K:
Income Statement: we made $393 million of adjustments with a net effect of removing $185 million in non-operating expenses (2% of revenue). See all adjustments made to J.M. Smucker’s income statement here.
Balance Sheet: we made $1.3 billion of adjustments to calculate invested capital with a net increase of $1.1 billion. The most notable adjustment was $553 million (4% of reported net assets) in asset write-downs. See all adjustments to J.M. Smucker’s balance sheet here.
Valuation: we made $7.5 billion of adjustments with a net effect of decreasing shareholder value by $7.5 billion. There were no adjustments that increased shareholder value. Apart from total debt, one of the most notable adjustments to shareholder value was $1.4 billion in net deferred tax liabilities. This adjustment represents 10% of J.M. Smucker’s market value. See all adjustments to J.M. Smucker’s valuation here.
This article originally published on October 8, 2020.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
 Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.