A Quality Executive Compensation Plan Lowers The Risk Of Investing In Humana

Recap from July Picks

The Exec Comp Aligned with ROIC Model Portfolio (+4.4%) outperformed the S&P 500 (-0.3%) from July 14, 2023 through August 14, 2023. The best performing stock in the portfolio was up 25%. Overall, 9 out of the 15 Exec Comp Aligned with ROIC Stocks outperformed the S&P from July 14, 2023 through August 14, 2023.

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 August: Humana Inc.


Humana (HUM) is the featured stock in August’s Exec Comp Aligned with ROIC Model Portfolio.

Humana has grown revenue and net operating profit after tax (NOPAT) by 9% and 10% compounded annually, respectively, since 2012. The company’s NOPAT margin improved from 3% in 2016 to 4% in the trailing twelve months (TTM), while invested capital turns rose from 2.9 to 3.1 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 7% in 2016 to 11% in the TTM.

Figure 1: Humana’s Revenue & NOPAT: 2012 – TTM

Executive Compensation Properly Aligns Incentives

Humana’s executive compensation plan aligns the interests of executives and shareholders by tying its performance-based awards to three-year aggregated adjusted ROIC. According to Humana’s proxy statement, the company ties at least 55% of long-term incentives to adjusted ROIC.

The company’s inclusion of adjusted ROIC, a variation of ROIC, as a performance goal has helped create shareholder value by driving higher ROIC and economic earnings. When I calculate ROIC using superior fundamental data, I find that Humana’s ROIC has increased from 7% in 2016 to 11% in the TTM. Economic earnings rose from $705 million to $1.8 billion over the same time.

Figure 2: Humana’s ROIC: 2016 – TTM

HUM Has Further Upside

At the current price of $489/share, HUM has a price-to-economic book value (PEBV) ratio of 1.2. Though the company’s PEBV ratio is higher than other featured stocks, the stock still holds quality upside.

If I assume Humana’s NOPAT margin remains at 4% (equal to TTM margin) and the company grows revenue by 6% compounded annually (vs. consensus estimates of 10% in 2023 and 8% in 2024) over the next decade, the stock would be worth $612/share today – a 25% upside. See the math behind this reverse DCF scenario. In this scenario, Humana’s NOPAT grows 6% compounded annually through 2032.

For reference, Humana has grown NOPAT by 6% compounded annually since 2016. 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 made based on Robo-Analyst findings in Humana’s 10-Qs and 10-K:

Income Statement: I made $982 million in adjustments with a net effect of removing $246 million in non-operating expenses (<1% of revenue).

Balance Sheet: I made $6.8 billion in adjustments to calculate invested capital with a net increase of $6.8 billion. One of the largest adjustments was $1.4 billion (5% of reported net assets) in asset write-downs.

Valuation: I made $12.7 billion in adjustments, with a net effect of decreasing shareholder value by $12.7 billion. The largest adjustment to shareholder value was $12.6 billion in total debt, which includes $451 million in operating leases. This total debt adjustment represents 21% of Humana’s market value.

Disclosure: David Trainer, Kyle Guske II, Hakan Salt, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.

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