Six new stocks made September’s Dividend Growth Stocks Model Portfolio, which was made available to members on September 29, 2022.
Recap From August’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (-10.2%) outperformed the S&P 500 (-10.3%) by 0.1%, and on a total return basis, the Model Portfolio (-9.9%) outperformed the S&P 500 (-10.0%) by 0.1%. The best performing stock outperformed the S&P 500 by 7%. Overall, 19 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from August 26, 2022 through September 27, 2022.
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.
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.
Featured Stock From September: Lowe's Companies, Inc. (LOW: $200/share)
Lowe's Companies, Inc. (LOW) is the featured stock from September’s Dividend Growth Stocks Model Portfolio.
Lowe’s has grown revenue by 7% compounded annually and net operating profit after-tax (NOPAT) by 14% compounded annually over the past ten years. The company’s NOPAT margin rose from 5% in FYE 2012 (fiscal year end is 2/3/12) to 10% over the trailing twelve months (TTM), while the company’s invested capital turns rose from 1.5 to 2.6 over the same time. Rising NOPAT margins and invested capital turns drive Lowe’s return on invested capital (ROIC) from 7% in FYE 2012 to 25% TTM.
Figure 1: Lowe’s Revenue and NOAPT Since FYE 2012
Sources: New Constructs, LLC and company filings
FCF Exceeds Dividends by a Wide Margin
Lowe’s has increased its dividend in each of the past 48 years. The company increased its regular dividend from $1.52/share in FYE 2018 to $3.00/share in FYE 2022, or 17% compounded annually. The current quarterly dividend, when annualized, equals $4.20/share, and provides a 2.1% dividend yield.
More importantly, Lowe’s strong free cash flow (FCF) easily exceeds the company’s growing dividend payments. From FYE 2018 – 2022, Lowe’s cumulative $31.6 billion (20% of enterprise value) in FCF is nearly 4x the $8.0 billion paid out in dividends, per Figure 2. Over the TTM, the company generated $11.5 billion in FCF and paid out $2.2 billion in dividends.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Sources: New Constructs, LLC and company filings
Companies with FCF well above dividend payments provide higher quality dividend growth opportunities because we know the company 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.
Lowe’s Has Upside Potential
At its current price of $200/share, LOW has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means the market expects Lowe’s NOPAT to never rise above current levels. This expectation seems overly pessimistic for a company that has grown NOPAT by 20% compounded annually over the past five years and 14% compounded annually over the past decade.
Even if Lowe’s NOPAT margin falls to 8% (five-year average) and the company grows NOPAT by just 4% compounded annually for the next 10 years, the stock would be worth $250+/share today – a 25% upside. See the math behind the reverse DCF scenario.
Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Lowe’s 2.1% dividend yield and history of dividend growth, and it’s clear why this stock is in September’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 Lowe’s 10-Ks and 10-Qs:
Income Statement: We made $1.7 billion in adjustments with a net effect of removing $1.0 billion in non-operating expenses (1% of revenue). Clients can see all adjustments made to Lowe’s income statement on the GAAP Reconciliation tab on the Ratings page on our website.
Balance Sheet: We made $10.9 billion in adjustments to calculate invested capital with a net increase of $10.5 billion. The most notable adjustment was $6.5 billion (26% of reported net assets) in asset write-downs. Clients can see all adjustments made to Lowe’s balance sheet on the GAAP Reconciliation tab on the Ratings page on our website.
Valuation: We made $32.8 billion in adjustments, all of which decreased shareholder value. Apart from total debt, the most notable adjustment to shareholder value was $136 million in outstanding employee stock options. This adjustment represents <1% of Lowe’s market value. Clients can see all adjustments to Lowe’s valuation on the GAAP Reconciliation tab on the Ratings page on our website.
This article originally published on October 7, 2022.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
Follow us on Twitter, Facebook, LinkedIn, and StockTwits for real-time alerts on all our research.
[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.