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Interpublic Group Of Companies’ Cash Flow Increases The Safety Of Its Dividend Yield

Recap from May’s Picks

On a price return basis, the Safest Dividend Yields Model Portfolio (-2.0%) underperformed the S&P 500 (+1.3%) by 3.3% from May 20, 2021, through June 21, 2021. On a total return basis, the Model Portfolio (-1.6%) underperformed the S&P 500 (+1.3%) by 2.9% over the same time. The best performing large cap stock was up 4% and the best performing small cap stock was up 2%. Overall, one out of the 19 Safest Dividend Yield stocks outperformed its benchmark (S&P 500) from May 20, 2021, through June 21, 2021.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because I know they have the cash to support the dividend. I think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.

Featured Stock for June: Interpublic Group of Companies Inc. (IPG)

Interpublic Group of Companies Inc. (IPG) is the featured stock in June’s Safest Dividend Yields Model Portfolio.

Interpublic Group has grown revenue by 4% compounded annually and net operating profit after-tax (NOPAT) by 8% compounded annually over the past five years. Interpublic Group’s NOPAT margin increased from 8% in 2015 to 11% over the trailing-twelve-months (TTM) while its return on invested capital (ROIC) rose from 6% to 8% over the same time.

The firm’s economic earnings, or the true cash flows of the business, increased from $10 million in 2015 to $424 million over the TTM.

Figure 1: Interpublic Group of Companies’ Revenue And NOPAT Since 2015

Free Cash Flow Supports Dividend Payments

Interpublic Group has paid a dividend each year since 2011, and its dividend in 2020 was $1.02/share. The current quarterly dividend, when annualized provides a 3.3% dividend yield.

Since 2016, Interpublic Group’s cumulative Free Cash Flow (FCF) easily covers its annual dividend payments. Over the past five years, Interpublic Group generated $2.3 billion (18% of current market cap) in FCF while paying $1.6 billion in dividends, per Figure 2. The firm’s $2.3 billion acquisition of Acxiom Marketing Solutions drove the firm’s negative FCF in 2018.

Figure 2: Interpublic Group of Companies’ FCF vs. Dividends Since 2016

Companies with strong FCF provide higher quality dividend yields because I know the firm has the cash to support its dividend. On the other hand, dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.

IPG Is Undervalued

At its current price of $32/share, IPG has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects Interpublic Group’s NOPAT to permanently decline by 20%. This expectation seems overly pessimistic given that Interpublic Group has grown NOPAT by 8% compounded annually over the past decade and 3% compounded annually over the past two decades.

Even if Interpublic Group’s NOPAT margin falls to 9% (10-year average vs 11% TTM) and the firm grows NOPAT by just 2% compounded annually over the next decade, the stock is worth $39/share today – a 22% upside. See the math behind this reverse DCF scenario. Should the firm grow NOPAT more in line with historical growth rates, 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 Interpublic Group’s 10-K and 10-Q:

Income Statement: I made $1.0 billion in adjustments with a net effect of removing $544 million in non-operating expenses (6% of revenue). See all adjustments made to Interpublic Group’s income statement here.

Balance Sheet: I made $8.7 billion in adjustments to calculate invested capital with a net increase of $3.6 billion. The most notable adjustment was $2.5 billion (30% of reported net assets) related to goodwill. See all adjustments to Interpublic Group’s balance sheet here.

Valuation: I made $8.1 billion in adjustments with a net effect of decreasing shareholder value by $4.9 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $1.6 billion in excess cash. This adjustment represents 13% of Interpublic Group’s market value. See all adjustments to Interpublic Group’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.

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