One new stock made July’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of July 13, 2018.

Recap from June Picks

Our Exec Comp Aligned with ROIC Model Portfolio (-1.4%) underperformed the S&P 500 (-0.2%) last month. The best performing stock in the portfolio was Hasbro (HAS), which was up 6%. Overall, eight out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P in June.

Since inception, this model portfolio is up 28% while the S&P 500 is up 28% as well.

The success of this Model Portfolio highlights the value of our Robo-Analyst technology[1], which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.

This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. We think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.[2]

New Stock Feature for July: NVR Inc. (NVR: $3,071/share)

NVR Inc. (NVR), a homebuilder in the United States, is the featured stock in July’s Exec Comp Aligned with ROIC Model Portfolio. NVR was previously featured as a Long Idea in April 2017 and reiterated in November 2017. Since our original report, NVR is up 45% (vs. S&P 500 up 19%) and still remains undervalued. The mix of strong fundamentals and undervalued stock price also earns NVR a spot in our Focus List – Long Model Portfolio.

Since 2011, NVR has grown revenue by 15% compounded annually and after-tax operating profit (NOPAT) by 27% compounded annually, to $589 million in 2017. NOPAT has increased further, to $629 million, over the last twelve months. NVR’s NOPAT margin has improved from 5% in 2011 to 10% TTM. NVR has also generated cumulative free cash flow (FCF) of $1.2 billion (11% of market cap) over the past five years.

Figure 1: NVR’s Revenue & NOPAT Since 2011

Sources: New Constructs, LLC and company filings

Executive Compensation Plan Helps Drive Shareholder Value Creation

NVR has included return on capital as a performance metric in its executive compensation plan since 2014. In 2017, 50% of equity grants were tied to return on capital performance. For performance-based options, vesting is subject to NVR’s return on capital relative to its peer group.

The focus on return on capital helps ensure executives are good stewards of capital. Since adding return on capital to its compensation plan in 2014, NVR has grown ROIC from 19% to 26% TTM. This improvement follows a long-term trend, in which ROIC has improved from 12% in 2011, per Figure 2. NVR’s executive compensation plan lowers the risk of investing in the company’s stock because we know executives’ interests are tied to shareholders’ interests.

Figure 2: NVR’s ROIC Since 2011

Sources: New Constructs, LLC and company filings

NVR Still Provides Upside Potential

At its current price of $3,071/share, NVR has a price-to-economic book value (PEBV) ratio of 1.2. This ratio means the market expects NVR’s NOPAT to grow by no more than 20% over the remaining life of the firm. This expectation seems overly pessimistic for a firm that has grown NOPAT by over 20% compounded annually since 2011.

If NVR can maintain TTM NOPAT margins (10%) and grow NOPAT by just 8% compounded annually for the next decade, the stock is worth $4,540/share – a 48% upside. See the math behind this dynamic 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. Below are specifics on the adjustments we make based on Robo-Analyst findings in NVR’s 2017 10-K:

Income Statement: we made $55 million of adjustments, with a net effect of removing $51 million in non-operating expense (1% of revenue). We removed $2 million in non-operating income and $53 million in non-operating expenses. You can see all the adjustments made to NVR’s income statement here.

Balance Sheet: we made $1.6 billion of adjustments to calculate invested capital with a net increase of $587 million. One of the largest adjustments was $390 million due to asset write-downs. This adjustment represented 24% of reported net assets. You can see all the adjustments made to NVR’s balance sheet here.

Valuation: we made $1.8 billion of adjustments with a net effect of decreasing shareholder value by $1.7 billion. The largest adjustments to shareholder value was $1 billion in outstanding employee stock options. This adjustment represents 9% of NVR’s market cap. Despite the net decrease in shareholder value, NVR remains undervalued.

This article originally published on July 18, 2018.

Disclosure: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.

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[1] Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.

[2] Ernst & Young’s recent white paper, “Getting ROIC Right”, proves the superiority of our research and analytics.

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    2 replies to "Featured Stocks in July’s Exec Comp & ROIC Model Portfolio"

    • janet amighi

      We want companies to invest in R&D, to risk some losses to get long term gains.
      To pay good salaries and benefits to attract and keep good employees.
      I think this approach would work best if compensation is tied to long term gains only.

    • Sam McBride

      Agreed, the best way to align executives with shareholders is to tie compensation to long-term improvement in ROIC. However, using ROIC as an annual target is still better than EPS, Adjusted EBITDA, or TSR like most companies use.

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