Three new stocks make April’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of April 15, 2021.
Recap from March’s Picks
The Exec Comp Aligned with ROIC Model Portfolio (+3.8%) underperformed the S&P 500 (+4.8%) from March 12, 2021 through April 13, 2021. The best performing stock in the portfolio was up 12%. Overall, seven out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P from March 12, 2021 through April 13, 2021.
This Model Portfolio only includes stocks that earn an attractive or very attractive rating and align executive compensation with improving ROIC. I 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 April: NVR Inc. (NVR: $4,800/share)
NVR Inc. (NVR) is the featured stock in April’s Exec Comp Aligned with ROIC Model Portfolio.
I made NVR a Long Idea in April 2017. Since then, the stock is up 125% vs. 78% for the S&P 500 and still provides excellent risk/reward.
MORE FOR YOU
NVR has grown revenue by 8% compounded annually and net operating profit after tax (NOPAT) by 19% compounded annually over the past five years, per Figure 1. NOPAT margin increased from 8% in 2015 to 12% in 2020.
Figure 1: NVR’s NOPAT Growth: 2015 – 2020
Performance-Based Pay Properly Incentivizes Executives
NVR’s executive compensation plan aligns executives’ interests with shareholder’s interests by tying compensation to return on capital, which is similar to my calculation of return on invested capital (ROIC). Apart from base salaries and capped cash incentives, NVR compensates executives in the form of long-term stock-based awards, half of which are tied to the firm’s return on capital performance.
NVR’s inclusion of return on capital as an executive compensation metric has helped drive shareholder value creation and economic earnings, per Figure 2. NVR’s ROIC has improved from 21% in 2015 to 35% in 2020 while its economic earnings grew significantly from $282 million to $799 million over the same time.
Figure 2: NVR’s Economic Earnings: 2015 – 2020
NVR Is Undervalued
At its current price of $4,800/share, NVR has a price-to-economic book value (PEBV) ratio of 1.0. This ratio means that the market expects NVR’s NOPAT to never meaningfully grow from current levels. This expectation seems overly pessimistic for a firm that has grown NOPAT by 16% compounded annually over the past decade.
Even if NVR’s NOPAT margin falls to 8% (below the firm’s 10-year average of 9% and 12% in 2020) and the firm grows revenue by 8% (equal to its five-year CAGR from 2015-2020 and below its 10-year CAGR from 2010-2020) compounded annually over the next 10 years, the stock is worth $6,092/share today – a 27% upside. See the math behind this reverse DCF scenario. In this scenario, NVR’s NOPAT grows just 3% compounded annually over the next decade, which is well below its 16% compounded annual NOPAT growth over the prior decade.
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 NVR’s 10-K:
Income Statement: I made $34 million of adjustments, with a net effect of removing $34 million in non-operating expenses (<1% of revenue).You can see all the adjustments made to NVR’s 2020 income statement here.
Balance Sheet: I made $4.7 billion in adjustments to calculate invested capital with a net decrease of $557 million. One of the largest adjustments was $418 million (13% of reported net assets) in asset write-downs. You can see all the adjustments made to NVR’s balance sheet here.
Valuation: I made $5.2 billion of adjustments with a net effect of decreasing shareholder value by $573 million. Apart from total debt, the most notable adjustment to shareholder value was $2.3 billion in excess cash. This adjustment represents 13% of NVR’s market cap. See all adjustments to NVR’s valuation here.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.