Nine new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on September 23, 2021.
Recap from August’s Picks
On a price return basis, our Safest Dividend Yields Model Portfolio (-4.5%) underperformed the S&P 500 (-2.2%) by 2.3% from August 20, 2021 through September 21, 2021. On a total return basis, the Model Portfolio (-4.0%) underperformed the S&P 500 (-1.9%) by 2.1% over the same time. The best performing large cap stock was down 1% and the best performing small cap stock was up 2%. Overall, 5 out of the 19 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from August 20, 2021 through September 21, 2021.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research. Our proprietary Robo-Analyst technology[1] scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks[2] 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 September: Kellogg Company (K: $65/share)
Kellogg Company (K) is the featured stock in September’s Safest Dividend Yields Model Portfolio. Kellogg is a consistent profit generator through all economic cycles.
Kellogg has grown revenue by <1% compounded annually and net operating profit after-tax (NOPAT) by 1% compounded annually over the past five years. Kellogg’s NOPAT margin remained flat at 10% from 2015 to the trailing-twelve-month period (TTM) while its return on invested capital (ROIC) also remained flat at 9% over the same time.
The firm’s economic earnings, or the true cash flows of the business, increased from $823 million in 2015 to $960 million over the TTM.
Figure 1: Kellogg’s Revenue & Economic Earnings Since 2015
Sources: New Constructs, LLC and company filings
Free Cash Flow Supports Dividend Payments
Kellogg has paid an annual dividend every year since 1957 and has increased its dividend every year for the past 16 years. Its dividend in 2020 was $2.28/share, and the current quarterly dividend, when annualized, provides a 3.6% dividend yield.
Since 2015, Kellogg’s cumulative free cash flow (FCF) easily covers its standard dividend payments. Over the past five years, Kellogg generated $7 billion (31% of current market cap) in FCF while paying $4.5 billion in dividends, per Figure 2.
Figure 2: Kellogg’s FCF vs. Standard Dividends Since 2015
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.
K Is Undervalued
At its current price of $65/share, Kellogg has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects Kellogg’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that Kellogg has grown NOPAT by 4% compounded annually over the past two decades.
Even if Kellogg’s NOPAT margin falls to 8% (twenty-year low compared to 10% TTM) and the firm’s NOPAT falls by 2% compounded annually over the next decade, the stock is worth $99/share today – a 52% upside. See the math behind this reverse DCF scenario. Should the firm 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
Fact: we provide superior fundamental data and earnings models – unrivaled in the world.
Proof: Core Earnings: New Data & Evidence, forthcoming in The Journal of Financial Economics.
Below are specifics on the adjustments we make based on Robo-Analyst findings in Kellogg’s 10-K and 10-Q:
Income Statement: we made $554 million in adjustments with a net effect of removing $162 million in non-operating expenses (1% of revenue). See all adjustments made to Kellogg’s income statement here.
Balance Sheet: we made $3.8 billion in adjustments to calculate invested capital with a net increase of $3.0 billion. The most notable adjustment was $1.7 billion (14% of reported net assets) in other comprehensive income. See all adjustments Kellogg’s balance sheet here.
Valuation: we made $10.2 billion of adjustments to shareholder value, all of which decrease shareholder value. Apart from total debt, one of the most notable adjustments to shareholder value was $518 million in minority interests. This adjustment represents 2% of Kellogg’s market value. See all adjustments to Kellogg’s valuation here.
This article originally published on October 1, 2021.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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[1] Harvard Business School features our research automation technology in the case Disrupting Fundamental Analysis with Robo-Analysts.
[2] See how our models overcome flaws in Bloomberg and Capital IQ’s (SPGI) analytics in the detailed appendix of this paper.