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A Quality Exec Comp Plan Lowers The Risk Of Investing In Clorox

Two new stocks make October’s Exec Comp Aligned with ROIC Model Portfolio, available to members as of October 14, 2021.

Recap From September’s Picks

The Exec Comp Aligned with ROIC Model Portfolio (+1.8%) outperformed the S&P 500 (-3.2%) from September 15, 2021 through October 12, 2021. The best performing stock in the portfolio was up 15%. Overall, 11 out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P 500 from September 15, 2021 through October 12, 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 October: The Clorox Company (CLX)

The Clorox Company (CLX) is the featured stock in October’s Exec Comp Aligned with ROIC Model Portfolio.

Clorox grew revenue and net operating profit after tax (NOPAT) by 4% compounded annually over the past five years, per Figure 1. The company’s NOPAT margin grew from 12% in 2015 to 14% over the trailing twelve-month (TTM) period. The company’s ROIC grew from 11% to 13% over the same time.

Figure 1: Clorox’s NOPAT & Revenue Growth: 2015 – TTM

Economic Profit-Based Pay Properly Incentivizes Executives

Clorox’s executive compensation plan aligns executives’ interests with shareholder’s interests by tying its long-term equity compensation to its three-year annual economic profit (similar to my calculation of economic earnings) growth rate.

Clorox’s inclusion of economic profit as an executive compensation performance goal has helped drive shareholder value creation through rising ROIC and economic earnings. While Clorox’s ROIC improved from 11% in 2015 to 13% over the TTM, the company’s economic earnings also grew from $472 million to $785 million over the same time.

Figure 2: Clorox’s Economic Earnings: 2015 – TTM

CLX Is Undervalued

At its current price of $161/share, CLX has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects Clorox’s NOPAT to permanently decline by 40%. This expectation seems overly pessimistic for a company that has grown NOPAT by 5% compounded annually over the past two decades.

Even if Clorox’s NOPAT margin falls to 12% (equal to 10-year low, compared to 14% TTM) and the company’s NOPAT falls by <1% compounded annually over the next 10 years, the stock is worth $246/share today – a 53% upside. See the math behind this reverse DCF scenario. Should the company 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 Clorox’s 10-K and 10-Qs:

Income Statement: I made $692 million in adjustments, with a net effect of removing $292 million in non-operating expenses (4% of revenue). You can see all the adjustments made to Clorox’s income statement here.

Balance Sheet: I made $4.1 billion in adjustments to calculate invested capital with a net increase of $3.5 billion. One of the largest adjustments was $1.7 billion (40% of reported net assets) related to goodwill. You can see all the adjustments made to Clorox’s balance sheet here.

Valuation: I made $3.9 billion in adjustments with a net effect of decreasing shareholder value by $3.7 billion. Apart from total debt, the most notable adjustment to shareholder value was $181 million in minority interests. This adjustment represents 1% of Clorox’s market cap. See all adjustments to Clorox’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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