Recap From November’s Picks
Overall, 10 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from November 23, 2021 through December 27, 2021. On a price return basis, the Dividend Growth Stocks Model Portfolio (+0.5%) underperformed the S&P 500 (+1.9%) by 1.4%, and on a total return basis the Model Portfolio (+0.7%) underperformed the S&P 500 (+2.3%) by 1.6% The best performing stock was up 12%.
The methodology for this model portfolio mimics an All Cap Blend style with a focus on dividend growth. Selected stocks earn an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >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 still appreciate the power of dividends, especially growing dividends.
Featured Stock From December: Colgate-Palmolive Company
Colgate-Palmolive Company (CL) is the featured stock from December’s Dividend Growth Stocks Model Portfolio. I made Colgate-Palmolive a Long Idea in June 2018. Since then, the stock is up 34% while the S&P 500 is up 78%. Despite its underperformance, the stock still offers attractive risk/reward. See my most recent report on Colgate-Palmolive here.
Colgate-Palmolive has grown revenue by 1% compounded annually and net operating profit after-tax (NOPAT) by 4% compounded annually over the past five years. The firm’s NOPAT margin improved from 16% in 2015 to 18% over the trailing-twelve-month (TTM) period, while the firm’s economic earnings rose from $2.0 billion to $2.5 billion over the same time.
Figure 1: Colgate-Palmolive’s NOPAT & Revenue Since 2015
FCF Exceeds Dividends By Wide Margin
Colgate-Palmolive has increased its dividend for 59 consecutive years. The firm increased its regular dividend from $1.55/share in 2016 to $1.75/share in 2020, 3% compounded annually. The current quarterly dividend, when annualized, equals $1.80/share and provides a 2.1% dividend yield.
More importantly, Colgate-Palmolive’s strong free cash flow (FCF) exceeds the firm’s growing dividend payments. Colgate-Palmolive’s cumulative $11.7 billion (16% of current market cap) in FCF is nearly 1.5x the $7.9 billion in dividends paid out from 2016 to 2020, per Figure 2. Over the TTM, Colgate-Palmolive generated $2.7 billion in FCF and paid $1.7 billion in dividends. Figure 2 also shows that Colgate-Palmolive’s FCF significantly exceeded its dividend payments in four out of the past five years.
Figure 2: Free Cash Flow vs. Regular Dividend Payments
Companies with FCF well above dividend payments provide higher quality dividend growth opportunities because I know the firm generates the cash to support a higher dividend. On the other hand, the dividend of a company where FCF falls short of the dividend payment over time cannot be trusted to grow or even maintain its dividend because of inadequate free cash flow.
Colgate-Palmolive Has Upside Potential
At its current price of $85/share, CL has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects Colgate-Palmolive’s NOPAT to permanently decline by 10%. This expectation seems overly pessimistic for a firm that has grown NOPAT by 5% compounded annually over the past two decades.
Even if Colgate-Palmolive maintains TTM NOPAT margins of 18% (below five-year average of 19%) and grows NOPAT by just 2% compounded annually for the next decade, the stock is worth $105/share today – a 24% upside. See the math behind the reverse DCF scenario.
Should the firm grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Colgate-Palmolive’s 2.1% dividend yield and history of dividend growth, and it’s clear why this stock is in December’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I make based on Robo-Analyst findings in Colgate-Palmolive’s 10-Qs and 10-K:
Income Statement: I made $601 million in adjustments with a net effect of removing $370 million in non-operating expenses (2% of revenue). See all adjustments made to Colgate-Palmolive’s income statement here.
Balance Sheet: I made $7.2 billion of adjustments to calculate invested capital with a net increase of $5.4 billion. The most notable adjustment was $4.3 billion (38% of reported net assets) in other comprehensive income. See all adjustments to Colgate-Palmolive’s balance sheet here.
Valuation: I made $12.2 billion in adjustments with a net effect of decreasing shareholder value by $11.6 billion. Other than total debt, the most notable adjustment to shareholder value was $1.9 billion in underfunded pensions. This adjustment represents 3% of Colgate-Palmolive’s market value. See all adjustments to Colgate-Palmolive’s valuation here.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.