Recap from February’s Picks
On a price return basis, the Dividend Growth Stocks Model Portfolio (-4.7%) underperformed the S&P 500 (+0.1%) by 4.8% from February 28, 2023 through March 27, 2023. On a total return basis, the Model Portfolio (-4.5%) underperformed the S&P 500 (+0.4%) by 4.9% over the same time. The best performing stock was up 5%. Overall, nine out of 30 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from February 28, 2023 through March 27, 2023.
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 (FCF) 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.
Featured Stock for February: Snap-On Inc.
Snap-On (SNA) is the featured stock in March’s Dividend Growth Stocks Model Portfolio. I first made Snap-On a Long Idea in February 2018 and the stock is up 51% while the S&P 500 is up 52% since then.
Snap-On has grown revenue by 5% compounded annually and net operating profit after tax (NOPAT) by 9% compounded annually over the past decade. The company’s NOPAT margin has increased from 12% in 2012 to 19% in 2022. Even though invested capital turns fell slightly during that period, NOPAT margins increased enough to drive return on invested capital (ROIC) from 11% in 2012 to 16% in 2022.
Figure 1: Snap-On’s Revenue & NOPAT Since 2012
Free Cash Flow Supports Regular Dividend Payments
Snap-On has increased its regular dividend from $3.41/share in 2018 to $5.88/share in 2022, or 15% compounded annually. The current quarterly dividend, when annualized, equals $6.48/share and provides a 2.7% dividend yield.
More importantly, Snap-On’s free cash flow (FCF) easily exceeds its regular dividend payments. From 2018 through 2022, Snap-On generated $2.9 billion (22% of current enterprise value) in FCF while paying $1.2 billion in dividends. See Figure 2.
Figure 2: Snap-On’s FCF vs. Regular Dividends Since 2018
Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.
SNA Is Undervalued
At its current price of $237/share, Snap-On has a price-to-economic book value (PEBV) ratio of 1.1. This ratio means the market expects Snap-On’s NOPAT to increase just 10% from 2022 levels over the life of the company. This expectation seems overly pessimistic given that Snap-On has grown NOPAT by 9% compounded annually over the past decade and 12% compounded annually over the past two decades.
Even if Snap-On maintains its 2022 NOPAT margin of 19% and grows revenue by just 4% compounded annually over the next decade, the stock would be worth $285/share today – a 20% upside. In this scenario, Snap-On’s NOPAT would grow just 4% compounded annually through 2032. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.
Add in Snap-On’s 2.7% dividend yield and a history of dividend growth, and it’s clear why this stock is in March’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I make based on Robo-Analyst findings in Snap-On’s 10-K:
Income Statement: I made $134 million in adjustments with a net effect of removing $26 million in non-operating expenses (<1% of revenue).
Balance Sheet: I made $1.8 billion in adjustments to calculate invested capital with a net decrease of $168 million. The most notable adjustment was $528 million (9% of reported net assets) in other comprehensive income.
Valuation: I made $1.9 billion in adjustments, with a net decrease of $605 million in shareholder value. Apart from total debt, one of the most notable adjustments to shareholder value was $660 million in excess cash. This adjustment represents 5% of Snap-On’s market value.
Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.
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