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Recap From January’s Picks
The Exec Comp Aligned with ROIC Model Portfolio (-3.2%) underperformed the S&P 500 (-1.5%) from January 13, 2022, through February 9, 2022. The best performing stock was up 15%. Overall, four out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P 500 from January 13, 2022, through February 9, 2022.
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 February: PulteGroup Inc.
PulteGroup Inc. (PHM) is the featured stock in February’s Exec Comp Aligned with ROIC Model Portfolio.
PulteGroup has grown revenue and net operating profit after tax (NOPAT) by 13% and 31% compounded annually, respectively, over the past decade, per Figure 1. The company’s NOPAT margin rose from 3% in 2011 to 15% in 2021, while invested capital turns improved from 0.4 to 1.0 over the same time. Rising NOPAT margins and invested capital turns drive the company’s ROIC from 1% in 2011 to 15% in 2021.
Figure 1: PulteGroup’s NOPAT & Revenue Growth: Fiscal 2011 – 2021
PHM NOPAT And Revenue
New Constructs, LLC
Executive Compensation Properly Aligns Incentives
PulteGroup’s executive compensation plan aligns executives’ interests with shareholders’ interests by tying the payout of restricted share units to the achievement of a three-year target ROIC.
PulteGroup’s inclusion of ROIC as an executive compensation performance goal has helped drive shareholder value creation through rising ROIC and economic earnings. PulteGroup’s ROIC improved from 6% in 2016 to 15% in 2021 and the company’s economic earnings grew from $73 million to $1.2 billion over the same period.
Figure 2: PulteGroup’s ROIC: 2016 – 2021
PHM ROIC Since 2016
New Constructs, LLC
At its current price of $49/share, PHM has a price-to-economic book value (PEBV) ratio of 0.4. This ratio means the market expects PulteGroup’s NOPAT to permanently decline by 60%. This expectation seems overly pessimistic for a company that has grown NOPAT by 10% compounded annually over the past two decades.
PulteGroup Is Undervalued
If PulteGroup’s NOPAT margin falls to 11% (10-year average vs. 15% in 2021) and the company’s NOPAT falls 2% compounded annually over the next 10 years, the stock is worth $103/share today – a 110% upside. See the math behind this reverse DCF scenario. Should the company’s NOPAT fall at a slower rate, or even grow from 2021 levels, the stock has even more upside.
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 PulteGroup’s 10-K:
Income Statement: I made $358 million in adjustments, with a net effect of removing $176 million in non-operating expenses (1% of revenue).
Balance Sheet: I made $7.4 billion in adjustments to calculate invested capital with a net increase of $3.8 billion. One of the largest adjustments was $5.6 billion (57% of reported net assets) in asset write-downs.
Valuation: I made $3.7 billion in adjustments with a net effect of decreasing shareholder value by $1.5 billion. Apart from total debt, the most notable adjustment to shareholder value was $1.1 billion in excess cash. This adjustment represents 9% of PulteGroup’s market cap.
Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
