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Summary of August picks
Based on price return, the model portfolio of dividend growth stocks (-5.4%) outperformed the S&P 500 (-5.6%) by 0.2% between August 30, 2023 and 26 September 2023. Based on total return, the model portfolio (-5.1%) outperformed the S&P 500 (-5.2%) by 0.1% over the same period. The top-performing stock rose 8%. Overall, 15 of 28 dividend growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from August 30, 2023 to September 26, 2023.
This model portfolio’s methodology mimics an “All Cap Blend” style with an emphasis on dividend growth. Selected stocks achieve an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield greater than 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 who nevertheless appreciate the power of dividends, especially growing dividends.
Featured Action for September: Lockheed Martin
LMT
LMT
Lockheed Martin Corp (LMT) is the featured stock in the September Dividend Growth Stock Model Portfolio.
Lockheed Martin has grown its revenue by 6% compounded annually and its net operating profit after tax (NOPAT) by 9% compounded annually since 2016. The company’s NOPAT margin increased from 9% in 2016 to 11 % on the TTM, while the turnover of invested capital increased from 1.0 to 1.4 over the same period. Higher invested capital turnover and NOPAT margins increase return on invested capital (ROIC) from 9% in 2016 to 16% TTM.
Figure 1: Lockheed Martin revenue and NOPAT since 2016
LMT and NOPAT revenues 2016-TTM
Free cash flow supports regular dividend payments
Lockheed Martin increased its regular dividend from $1.82/share in 4Q16 to $3.00/share in 2Q23. The current quarterly dividend, when annualized, equals $12.00/share and provides a dividend yield of 3.0%.
More importantly, Lockheed Martin’s free cash flow (FCF) far exceeds its regular dividend payments. From 2017 to 2Q23, Lockheed Martin generated $42.0 billion (33% of current enterprise value) in FCF while paying $17.3 billion in dividends. See Figure 2.
Figure 2: Lockheed Martin FCF vs regular dividends since 2017
LMT FCF vs 2017-TTM Dividends
Companies with FCF well above dividend payouts provide higher quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even maintain.
LMT is undervalued
At its current price of $404/share, Lockheed Martin has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means that the market expects that Lockheed Martin’s NOPAT will never continue to rise again. This expectation seems too pessimistic given that Lockheed Martin has increased NOPAT by 9% per year since 2016 and 13% per year since 2000.
Even if Lockheed Martin’s NOPAT margin remains at 11% (five-year average) and revenue grows only 4% per year through 2032, the stock would be worth $523/share today, or a increase of 29%. See the math behind this reverse DCF scenario. In this scenario, Lockheed Martin’s NOPAT would only grow 4% annually through 2032. If the company’s NOPAT increased further in line with historical growth rates, the stock would have even more upside potential.
Add to that Lockheed Martin’s 3.0% dividend yield and a history of dividend growth, and you’ll see why this stock is in the September Dividend Growth Stock Model Portfolio.
Critical details found in financial documents by my company’s Robo-Analyst technology
Below are details of the adjustments I make based on the Robo-Analyst’s findings in Lockheed Martin’s 10-K and 10-Q:
Income Statement: I made $2.8 billion in adjustments with the net effect of removing $1.8 billion in non-operating expenses (3% of revenue).
Bottom line: I made $22.5 billion in adjustments to calculate invested capital with a net increase of $11.8 billion. The most notable adjustment was $8 billion (22% of reported net assets) in other comprehensive income.
Valuation: I made adjustments of $24.3 billion, with a net decrease in shareholder value of $23.7 billion. The most notable adjustment to shareholder value was total debt of $17.9 billion. This adjustment represents 18% of Lockheed Martin’s market value.
Disclosure: David Trainer, Kyle Guske II, Italo Mendonça, and Hakan Salt receive no compensation for writing on any specific title, style, or theme.