Written By: David Trainer
Recap from September’s Picks
The best performing stock in the portfolio was up 6%. Overall, four out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P in September.
This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating and align executive compensation with improving ROIC. We 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 October: NVR Inc. (NVR)
NVR Inc. (NVR[NYE] – $2,242.04 ) is the featured stock in October’s Exec Comp Aligned with ROIC Model Portfolio. NVR was previously featured as a Long Idea in April 2017 and reiterated in November 2017. The stock has fallen in recent months as homebuilding has slowed, and the market underappreciates NVR’s rising profitability.
Since 2011, NVR has grown revenue by 15% compounded annually and after-tax operating profit (NOPAT) by 27% compounded annually, to $589 million in 2017, per Figure 1. NOPAT has increased further, to $651 million, over the trailing twelve months (TTM), which is up 23% over the prior TTM period. NVR’s NOPAT margin has improved from 5% in 2011 to 10% TTM.
Figure 1: NVR Revenue & NOPAT Since 2011
Sources: New Constructs, LLC and company filings
Executive Compensation Plan Helps Drive Shareholder Value Creation
NVR has included return on capital as a performance metric in its executive compensation plan since 2014. Last year, 50% of equity grants were tied to return on capital performance. For performance-based options, vesting is subject to NVR’s return on capital relative to its peer group.
The focus on return on capital helps ensure executives are aligned with shareholders’ interests. Since adding return on capital to its compensation plan in 2014, NVR has grown ROIC from 19% to 26% TTM. This improvement follows a long-term trend, in which ROIC has improved from 12% in 2011, per Figure 2. NVR’s executive compensation plan lowers the risk of investing in the company’s stock because we know executives’ interests are tied to shareholders’ interests.
Figure 2: NVR’s ROIC Since 2011
Sources: New Constructs, LLC and company filings
NVR Provides Significant Upside Potential
At its current price of $2,101/share, NVR has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects NVR’s NOPAT to permanently decline by 20%. This expectation seems overly pessimistic for a firm that has grown NOPAT by over 20% compounded annually since 2011.
If NVR can maintain TTM NOPAT margins (10%) and grow NOPAT by just 5% compounded annually for the next decade, the stock is worth $3,749/share – a 78% upside. See the math behind this dynamic 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. Below are specifics on the adjustments we make based on Robo-Analyst findings in NVR’s 2017 10-K:
Income Statement: we made $55 million of adjustments, with a net effect of removing $51 million in non-operating expense (1% of revenue). You can see all the adjustments made to NVR’s income statement here.
Balance Sheet: we made $1.6 billion of adjustments to calculate invested capital with a net increase of $587 million. One of the largest adjustments was $390 million in asset write-downs. This adjustment represented 24% of reported net assets. You can see all the adjustments made to NVR’s balance sheet here.
Valuation: we made $1.3 billion of adjustments with a net effect of decreasing shareholder value by $1.2 billion. Apart from $692 million in total debt, which includes $95 million in operating leases, one of the largest adjustments to shareholder value was $551 million in outstanding employee stock options. This adjustment represents 7% of NVR’s market cap. Despite the net decrease in shareholder value, NVR remains undervalued.
Disclosure: David Trainer and Kyle Guske II 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.
 Ernst & Young’s recent white paper, “Getting ROIC Right”, proves the superiority of our research and analytics.
DISCLOSURE: Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.
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