Twelve new stocks make our Safest Dividend Yield Model Portfolio this month, which was made available to members on January 24, 2019.
Recap from December’s Picks
Our Safest Dividend Yields Model Portfolio outperformed the S&P 500 last month. The Model Portfolio rose 8.5% on a price return basis and 9.0% on a total return basis. The S&P 500 rose 6.3% on a price return basis and 6.9% on a total return basis. The best performing large cap stock was up 21% and the best performing small cap stock was up 23%. Overall, 9 out of the 20 Safest Dividend Yield stocks outperformed the S&P in December.
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 January: Lam Research Corporation
Lam Research Corporation
LRCX was featured as a Long Idea in May 2018 and is down 15% while the S&P 500 is down 1% since publish date. However, the stock has bounced back by ~23% so far in 2019.
LRCX has grown revenue by 16% compounded annually over the past decade, and its after-tax operating profit (NOPAT) has grown 22% compounded annually over the same time. LRCX’s NOPAT margin has increased from 4% in 2013 to 27% over the last twelve months (TTM). The company has also improved its return on invested capital (ROIC) from 3% in 2013 to a top-quintile 53% TTM.
Figure 1: LRCX’s Revenue and Profit Growth Since 2008
Image Source: New Constructs, LLC
Sources: New Constructs, LLC and company filings
LRCX’s Free Cash Flow Supports Dividend Payments
After initiating quarterly dividends in 2014, LRCX has increased its quarterly dividend payment every year, from $0.18/share to $1.10/share in 2018, or 57% compounded annually, supported by the company’s free cash flow. From 2015 to 2018, LRCX generated a cumulative $5.5 billion (21% of market cap) in FCF while paying $857 million in dividends.
Companies with strong free cash flow provide higher quality dividend yields because we know the firms have the cash to support their dividends. On the flip side, dividends from companies with low or negative free cash flow cannot be trusted as much because the companies may not be able to sustain paying dividends.
Figure 2: LRCX’s FCF vs. Dividends Since 2015
Image Source: New Constructs, LLC
Sources: New Constructs, LLC and company filings
LRCX Remains Undervalued
At its current price of $173/share, LRCX has a price-to-economic book value (PEBV) ratio of 0.8. This ratio implies that the market expects LRCX’s NOPAT to permanently decline by 20%. This expectation seems pessimistic given that LRCX has grown NOPAT by 22% compounded annually since 2008.
If LRCX can maintain 2018 NOPAT margins (28%) and grow NOPAT by just 5% compounded annually for the next 10 years, the stock is worth $304/share today – a 76% 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 LRCX’S 2018 10-K:
Income Statement: we made $948 million of adjustments with a net effect of removing $746 million in non-operating expenses (7% of revenue). See all adjustments made to LRCX’s income statement here.
Balance Sheet: we made $6.8 billion of adjustments to calculate invested capital with a net decrease of $4.1 billion. The most notable accounting distortion to reported net assets for LRCX in 2018 is $417 million due to asset write downs, which is 4% of reported net assets. See all adjustments to LRCX’s balance sheet here.
Valuation: we made $5.6 billion of adjustments with a net effect of increasing shareholder value by $1.3 billion. The largest adjustment to shareholder value was $3.4 billion in excess cash. This adjustment represents 13% of LRCX’s market value.
This article originally published on February 1, 2019.
Disclosure: David Trainer, Andrew Gallagher, 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 holdings research and analytics.
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