11 new stocks make our Safest Dividend Yields Model Portfolio this month, which was made available to members on May 20, 2020.
Recap from April’s Picks
On a price return basis, our Safest Dividend Yields Model Portfolio (+13.1%) outperformed the S&P 500 (+5.7%) by 7.4% from April 22, 2020 through May 18, 2020. On a total return basis, the Model Portfolio (+13.6%) outperformed the S&P 500 (+5.7%) by 7.9% over the same time. The best performing large cap stock was up 33%, and the best performing small cap stock was up 50%. Overall, 12 out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from April 22, 2020 through May 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 May: Verizon Communications, Inc. (VZ: $55/share)
Verizon Communications, Inc. (VZ), is the featured stock in May’s Safest Dividend Yields Model Portfolio.
We first made Verizon a Long Idea in September 2015 and closed the position in June 2017 for no gain. We again made Verizon a Long Idea in September 2019. Since then, VZ is down 5% while the S&P 500 is up 3%.
Verizon has grown revenue by 2% compounded annually and net operating profit after-tax (NOPAT) by 9% compounded annually since 2016. Longer term, Verizon has grown NOPAT by 8% compounded annually over the past two decades. The firm’s NOPAT margin has increased from 15% in 2016 to 18% over the trailing-twelve-months (TTM), while its return on invested capital (ROIC) improved from 6.8% to 7.4% over the same time.
Figure 1: Verizon’s Revenue & NOPAT Since 2016
Sources: New Constructs, LLC and company filings
Cash Flow Supports Dividend Payments
Verizon has increased its dividend for 14 consecutive years and stated in its 1Q20 earnings call that it was in a “very good position” to continue dividend payments. The firm increased its dividend payments from $2.23/share in 2015 to $2.44/share in 2019, or 2% compounded annually. The current quarterly dividend, when annualized, equals $2.46/share and provides a 4.5% dividend yield. Verizon’s dividend payment has been supported by the firm’s strong free cash flow (FCF). Verizon generated $52.1 billion (23% of current market cap) in FCF while paying $47.1 billion in dividends from 2015 to 2019, per Figure 2. Over the TTM period, Verizon has generated $12.9 billion in FCF and paid out $10.1 billion in dividends.
Figure 2: Verizon’s FCF Vs. Dividends Since 2015
Sources: New Constructs, LLC and company filings
Companies with strong FCF 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 FCF cannot be trusted as much because the company may not be able to sustain paying dividends.
VZ is Undervalued
At its current price of $55/share, Verizon has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects Verizon’s NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that Verizon has grown NOPAT by 9% compounded annually since 2016, and 4% compounded annually over the past decade.
Even if Verizon’s NOPAT margin falls to 15% (10-year low vs. 18% TTM) and the firm grows NOPAT by just 2% compounded annually for the next decade, the stock is worth $105/share today – a 91% 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 Verizon’s 2019 10-K:
Income Statement: we made $14.4 billion of adjustments with a net effect of removing $5.2 billion in non-operating expenses (4% of revenue). See all adjustments made to Verizon’s income statement here.
Balance Sheet: we made $153.0 billion of adjustments to calculate invested capital with a net increase of $71.8 billion. The most notable adjustment was $69.3 billion (28% of reported net assets) in deferred tax assets. See all adjustments to Verizon’s balance sheet here.
Valuation: we made $214.2 billion of adjustments with a net effect of decreasing shareholder value by $205.3 billion. Apart from total debt and net deferred tax liabilities, one of the most notable adjustments to shareholder value was $16.7 billion in underfunded pensions. This adjustment represents 7% of Verizon’s market value. See all adjustments to Verizon’s valuation here.
This article originally published on May 29, 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.