Nine new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on February 20, 2020.
Recap from January’s Picks
Our Safest Dividend Yields Model Portfolio underperformed the S&P 500 from January 22, 2020 through February 18, 2020. The Model Portfolio fell 0.1% on a price return basis and rose 0.1% on a total return basis. The S&P 500 rose 1.6% on a price return and total return basis. The best performing large cap stock was up 7%, and the best performing small cap stock was up 11%. Overall, eight out of the 20 Safest Dividend Yield stocks outperformed the S&P 500 & Russell 2000 from January 22, 2020 through February 18, 2020.
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, which scales our forensic accounting expertise (featured in Barron’s) across thousands of stocks.
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 February: Omnicom Group, Inc. (OMC: $78/share)
Omnicom Group, Inc. (OMC), is the featured stock in February’s Safest Dividend Yields Model Portfolio. We made OMC a Long Idea on May 9, 2018 and the stock remains undervalued.
Over the last decade, OMC has grown revenue by 2% compounded annually and after-tax operating profit (NOPAT) by 6% compounded annually. The firm’s NOPAT margin increased from 9% in 2015 to 12% in 2019 while return on invested capital (ROIC) improved from 12% to 15% over the same period.
Figure 1: OMC’s Revenue & NOPAT Since 2009
Sources: New Constructs, LLC and company filings
Strong Cash Flow Supports Dividend Payments
Since 2015, OMC has increased its annual dividend from $2.00/share to $2.60/share, or 7% compounded annually. This dividend payment has been supported by OMC’s strong free cash flow (FCF). Figure 2 shows the company consistently generates the free cash flow necessary to pay its dividend. OMC has generated $8.1 billion (48% of current market cap) in FCF while paying $2.6 billion in dividends since 2015.
Figure 2: OMC’s FCF Vs. Dividends Since 2015
Sources: New Constructs, LLC and company filings
Companies with strong free cash flow provide higher quality dividend yields because we know the firm has the cash to support its dividend. On the other hand, 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.
OMC Remains Undervalued
At its current price of $78/share, OMC has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects OMC’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that OMC has grown NOPAT by 6% compounded annually over the past decade and 7% compounded annually over the past two decades.
OMC’s economic book value, or no-growth value, is $160/share – a 105% upside to the current stock price. However, if OMC can maintain TTM margins of 12% and grow NOPAT by just 1% compounded annually for the next decade, the stock is worth $173/share today – a 122% 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 Omnicom Group’s 2019 10-K:
Balance Sheet: we made $8.5 billion of adjustments to calculate invested capital with a net increase of $1.3 billion. The most notable adjustment was $1.5 billion (14% of reported net assets) related to operating leases. See all adjustments to OMC’s balance sheet here.
Valuation: we made $11.8 billion of adjustments with a net effect of decreasing shareholder value by $4.7 billion. Apart from total debt, which includes the operating leases noted above, one of the most notable adjustments to shareholder value was $727 million in minority interests. This adjustment represents 4% of OMC’s market value. See all adjustments to OMC’s valuation here.
This article originally published on February 25, 2020.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
 Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.