Three new stocks make June’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of June 14, 2019.
This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. We think this combination provides a uniquely well-screened list of long ideas because return on invested capital (ROIC) is the primary driver of shareholder value creation.
New Stock Feature for June: NVR Inc. (NVR: $3,450/share)
NVR Inc. (NVR) is the featured stock in June’s Exec Comp Aligned with ROIC Model Portfolio.
Since 2013, NVR has grown after-tax operating profit (NOPAT) by 20% compounded annually. Trailing twelve month (TTM) NOPAT is up 19% over the prior TTM period. Profit growth has been fueled by rising NOPAT margins, which are up from 7% in 2013 to 10% TTM.
Figure 1: NVR Profit Growth Since 2013
Sources: New Constructs, LLC and company filings
Executive Compensation Plan Helps Drive Shareholder Value Creation
NVR’s return on invested capital (ROIC) has also improved from 19% to 32% over the same time.
NVR has included return on capital as a performance metric in its executive compensation plan since 2014. Last year, 50% of long-term stock options were tied to the firm’s return on capital performance. For performance-based options, vesting is subject to NVR’s return on capital relative to its peer group.
The focus on return on invested capital helps ensure intelligent capital allocation. Since adding ROIC to its compensation plan in 2014, NVR has improved its ROIC from 18% to 32% TTM. NVR’s executive compensation plan lowers the risk of investing in the company’s stock because we know executives’ interests are tied to shareholders’ interests.
NVR Provides Significant Upside Potential
At its current price of $3,450/share, NVR has a price-to-economic book value (PEBV) ratio of 1.1. This ratio means the market expects NVR’s NOPAT to grow by no more than 10% over the remaining life of the firm. This expectation seems pessimistic given that NVR has grown NOPAT by 20% compounded annually since 2013 and 12% compounded annually since 1998.
If NVR can maintain TTM NOPAT margins (10%) and grow NOPAT by just 4% compounded annually for the next decade, the stock is worth $4,299/share today – a 25% 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 NVR’s 2018 10-K:
Income Statement: we made $133 million of adjustments, with a net effect of removing $55 million in non-operating income (1% of revenue). You can see all the adjustments made to NVR’s income statement here.
Balance Sheet: we made $1.9 billion of adjustments to calculate invested capital with a net increase of $539 million. One of the largest adjustments was $396 million due to asset write-downs. This adjustment represented 22% of reported net assets. You can see all the adjustments made to NVR’s balance sheet here.
Valuation: we made $2.4 billion of adjustments with a net effect of decreasing shareholder value by $1.6 billion. The largest adjustments to shareholder value was $1.3 billion in outstanding employee stock options. This adjustment represents 10% of NVR’s market cap. See all adjustments to NVR’s valuation here.
This article originally published on June 20, 2019.
Disclosure: David Trainer, Kyle Guske II, and Sam McBride 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.