Featured Stock From February: Procter & Gamble Co.
Procter & Gamble Co, (PG) is the featured stock from February’s Dividend Growth Stocks Model Portfolio.
Procter & Gamble has grown revenue by 3% compounded annually and net operating profit after-tax (NOPAT) by 7% compounded annually since fiscal 2017. The firm’s NOPAT margin has increased from 17% in fiscal 2017 to 20% over the trailing-twelve-months while invested capital turns have improved from 0.57 to 0.63 over the same time. Rising NOPAT margin and invested capital turns drive Procter & Gamble’s return on invested capital (ROIC) from 10% in fiscal 2017 to 13% TTM.
Figure 1: Procter & Gamble NOPAT & Revenue Since Fiscal 2017
Sources: New Constructs, LLC and company filings
Steady Dividend Growth Supported by FCF
Procter & Gamble has increased its regular dividend in every year of our model (dates back 24 years) and from $2.66/share in fiscal 2016 to $3.03/share in fiscal 2020, or 3% compounded annually. The current quarterly dividend, when annualized, equals $3.16/share and provides a 2.6% dividend yield.
More importantly, Procter & Gamble’s strong free cash flow (FCF) supports the firm’s growing dividend payments. Procter & Gamble generated a cumulative $66 billion (22% of current market cap) in FCF while paying $37.3 billion in dividends from fiscal 2016 to fiscal 2020, per Figure 2. Over the TTM, Procter & Gamble generated $13.9 billion in free cash flow and paid $8 billion in dividends.
Figure 2: Free Cash Flow 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.
PG Has Upside Potential
At its current price of $124/share, PG has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects Procter & Gamble’s NOPAT to permanently decline by 20%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 6% compounded annually over the past two decades.
Even if Procter & Gamble’s NOPAT margin falls to 18% (five-year average vs. 20% TTM), and the firm grows NOPAT by just 2% compounded annually for the next decade, the stock is worth $183/share today – a 48% upside. See the math behind the reverse DCF scenario. Add in Procter & Gamble’s 2.6% dividend yield and history of dividend growth, and it’s clear why this stock is in February’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 Procter & Gamble’s 10-Qs and 10-K:
Income Statement: we made $2.4 billion of adjustments with a net effect of removing $869 million in non-operating expenses (1% of revenue). See all adjustments made to Procter & Gamble’s income statement here.
Balance Sheet: we made $58.3 billion of adjustments to calculate invested capital with a net increase of $28.7 billion. The most notable adjustment was $16.2 billion (18% of reported net assets) in other comprehensive income. See all adjustments to Procter & Gamble’s balance sheet here.
Valuation: we made $62.1 billion of adjustments with a net effect of decreasing shareholder value by $41.1 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $10.5 billion in excess cash. This adjustment represents 3% of Procter & Gamble’s market value. See all adjustments to Procter & Gamble’s valuation here.
Recap From January’s Picks
On a price return basis, our Dividend Growth Stocks Model Portfolio (-0.2%) underperformed the S&P 500 (+2.6%) by 2.8% from January 28, 2021 through February 23, 2021. On a total return basis, the Model Portfolio (+0.1%) underperformed the S&P 500 (+2.6%) by 2.5% over the same time. The best performing stock was up 11%. Overall, six out of the 20 Dividend Growth Stocks outperformed the S&P 500 from January 28, 2021 through February 23, 2021.
More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research. Our Robo-Analyst technology scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks to produce an unrivaled database of fundamental data.
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 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 article originally published March 5, 2021.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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