Recap From September’s Picks
Our Safest Dividend Yields Model Portfolio outperformed the S&P 500 from September 20, 2019 through October 21, 2019. The Model Portfolio rose 1.7% on a price return basis and 2.0% on a total return basis. The S&P 500 rose 0.6% on a price return basis and 1.0% on a total return basis. The best performing large cap stock was up 9%, and the best performing small cap stock was up 9% as well. Overall, 13 out of the 20 Safest Dividend Yield stocks outperformed the S&P from September 20, 2019 through October 21, 2019.Only our research utilizes the superior data and earnings adjustments featured by the HBS & MIT Sloan paper, "Core Earnings: New Data and Evidence.” This Model Portfolio leverages our Robo-Analyst technology[1], which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.[2]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 October: General Mills (NYSE:GIS: $50/share)
General Mills (NYSE:GIS), is the featured stock in October’s Safest Dividend Yields Model Portfolio.
GIS has grown revenue by 1% compounded annually and after-tax operating profit (NOPAT) by 4% compounded annually over the past decade. Trailing twelve month (TTM) NOPAT is up 17% over the prior TTM period. NOPAT growing faster than revenue is driven by GIS’ rising NOPAT margin, which has increased from 10% in 2009 to 14% TTM.
Sources: New Constructs, LLC and company filings
GIS’ Free Cash Flow Supports Dividend Payments
Since 2015, GIS has increased its annual dividend from $1.67/share to $1.96/share, or 4% compounded annually. This dividend payment has been supported by GIS’ cumulative free cash flow. With the exception of 2018, when General Mills (NYSE:GIS) acquired Blue Buffalo Pet Products, the company consistently generates the free cash flow necessary to pay its dividend, per Figure 2. Excluding 2018, GIS generated $8.7 billion (29% of market cap) in FCF while paying $4.4 billion in dividends since 2015.Sources: New Constructs, LLC and company filingsCompanies with strong free cash flow provide higher quality dividend yields because we know the firm has the cash to support its dividend. On the flip side, dividends from companies with low or negative free cash flow cannot be trusted as much because the company may not be able to sustain paying dividends.
GIS’ Valuation Implies Permanent Profit Decline
At its current price of $50/share, GIS has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects GIS’ NOPAT to permanently decline by 20%. This expectation seems too pessimistic given that GIS has grown NOPAT by 4% compounded annually over the past decade and 7% compounded annually over the past two decades.
If GIS can maintain TTM NOPAT margins (14%) and grow NOPAT by just 2% compounded annually for the next decade, the stock is worth $73/share today – a 46% upside. See the math behind this reverse 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 as shown in the Harvard Business School and MIT Sloan paper, "Core Earnings: New Data and Evidence”.
Below are specifics on the adjustments we make based on Robo-Analyst findings in General Mills’ 2019 10-K:
Income Statement: we made $1.4 billion of adjustments with a net effect of removing $512 million in non-operating expenses (3% of revenue). See all adjustments made to GIS’ income statement here.
Balance Sheet: we made $7.3 billion of adjustments to calculate invested capital with a net increase of $7.3 billion. The most notable adjustment was $2.7 billion (12% of reported net assets) related to other comprehensive income. See all adjustments to GIS’ balance sheet here.
Valuation: we made $18.6 billion of adjustments with a net effect of decreasing shareholder value by $18.6 billion. There were no adjustments that increased shareholder value. Apart from total debt, the largest adjustment to shareholder value was $2 billion in deferred tax liabilities. This adjustment represents 7% of GIS’ market value. See all adjustments to GIS’ valuation here.