Summary of May Choices
Based on price performance, the Dividend Growth Stocks model portfolio (-2.4%) underperformed the S&P 500 (+ 2.0%) by 4.4% from May 27, 2021 to June 28, 2021. On Based on total return, the Model Portfolio (-2.0%) underperformed the S&P 500 (+ 2.0%) by 4.0% over the same period. The best performing stock rose 7%. Overall, four of the 30 dividend growth stocks outperformed the S&P 500 from May 27, 2021 to June 28, 2021.
The methodology of this model portfolio mimics an All Cap Blend style with an emphasis on dividend growth. The selected stocks achieve an attractive or very attractive rating, generate free cash flow (FCF) and positive economic earnings, offer a current dividend yield> 1% and have a history of more than 5 years of consecutive dividend growth. This model portfolio is designed for investors who focus more on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.
Featured Action From June: T. Rowe Price Inc. (TROW)
T. Rowe Price Inc. (TROW) is the flagship stock in the June Dividend Growth Equity Model Portfolio.
T. Rowe Price has increased its revenue by 10% compounded annually and net operating income after tax (NOPAT) by 14% compounded annually over the past ten years. Most recently, the company has grown NOPAT by 15% compounded annually over the past five years. The company’s rolling 12-month return (TTM) on invested capital (ROIC) is 36%, which is higher than the company’s average ROIC of 25% since 2010.
Figure 1: NOPAT and T. Rowe Price’s income since 2015
Steady dividend growth supported by the FCF
T. Rowe Price has increased his regular dividend annually for the past eight years and from $ 2.36 / share in 2012 to $ 3.60 / share in 2020, or 5% compounded annually. The current quarterly dividend, when annualized, is $ 4.32 / share and offers a dividend yield of 2.2%.
More importantly, T. Rowe Price’s strong Free Cash Flow (FCF) supports the company’s growing dividend payments. T. Rowe Price has generated a cumulative $ 5.0 billion (11% of current market cap) in FCF while paying $ 3.4 billion in dividends from 2016 to 2020, as shown in Figure 2. Over of the TTM period, T. Rowe Price generated $ 1.5 billion in FCF and paid $ 883 million in dividends.
Figure 2: Free Cash Flow Versus Regular Dividend Payments
Companies with FCFs that far exceed dividend payouts offer opportunities for higher quality dividend growth because I know the company is generating the cash to support a higher dividend. On the other hand, one cannot trust the dividend of a company where the FCF is lower than the dividend payout over time to increase or even maintain its dividend due to insufficient free cash flow.
TROW has upside potential
At its current price of $ 204 / share, TROW has an Economic Price-to-Book Value (PEBV) of 0.9. This ratio means that the market expects T. Rowe Price’s NOPAT to decline permanently by 10%. This expectation seems too pessimistic for a company that has grown NOPAT by 14% per year over the past decade.
Even though T. Rowe Price’s NOPAT margin drops to 33% (10-year average vs. 47% TTM) and the company’s NOPAT only increases by 5% compounded annually for the next decade, the share is worth $ 251 / share today – a 23% increase. See the math behind the reverse DCF scenario.
If the company grows NOPAT more in line with historical growth rates, the stock has even more potential. Add T. Rowe Price’s 2.2% dividend yield and dividend growth history, and you’ll see why this stock is part of the June Dividend Growth Stock Model Portfolio.
Critical details found in financial documents by my company’s Robo-Analyst technology
Below are details of the adjustments I make based on Robo-Analyst’s findings in T. Rowe Price’s papers:
Income statement: I made $ 252 million of adjustments with a net effect of eliminating $ 197 million of non-operating expenses (3% of revenue). See all adjustments to T. Rowe Price’s income statement here.
Balance sheet: I made $ 390 million of adjustments to calculate invested capital with a net decrease of $ 251 million. The most notable adjustment was $ 61 million (1% of reported net assets) in deferred tax assets. See all of T. Rowe Price’s balance sheet adjustments here.
Valuation: I made adjustments of $ 1.5 billion, all of which decreased shareholder value. The most notable adjustment in shareholder value was $ 1 billion in minority interests. This adjustment represents 2% of the market value of T. Rowe Price. See all T. Rowe Price valuation adjustments here.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation for writing about a specific action, style, or theme.