This Dividend King Soared 18.9% in 2023. Is There More Room to Run in 2024?

Dividend Kings are companies that have paid and raised their dividends for at least 50 years, a testament to consistent performance and growing earnings.

Many Dividend Kings are slow and stodgy industry-leading businesses in stable sectors like consumer staples, utilities, or healthcare. Then there's Illinois Tool Works (ITW 0.05%), commonly referred to as ITW.

ITW's business segments each have their fair share of volatility. The company is an industrial conglomerate with a diverse portfolio across different industries, including automotive, food equipment, test and measurement, electronics, welding, polymers and fluids, construction products, and specialty products. But unlike other conglomerates, like Honeywell or 3M, that have underperformed the market, ITW has outperformed the market over the last five years, producing a 119.4% total return (including dividends) compared to 100.6% for the S&P 500. ITW stock gained 18.9% last year, below the S&P 500's 24.2% gain but still a solid performance.

Not many large, established industrial stocks have been able to keep pace with the market's gains, especially because so many of those gains have been driven by megacap tech stocks. But ITW has. Here's the secret to ITW's success and why the stock could still be worth buying despite hovering around an all-time high.

Image source: Getty Images.

High-quality growth

The basic idea of investing in a stock is that you think earnings will be higher in the future than they are today. Sometimes, a company isn't profitable today, but investors are still willing to pay up for growth down the road (think Netflix or Amazon 10 years ago). But other times, a company is already profitable and isn't growing as quickly, so investors aren't willing to pay as much of a premium since earnings a few years from now aren't expected to be much higher than today's earnings.

The biggest problem with ITW is that it has a 24.6 price-to-earnings ratio, which isn't terribly expensive relative to the market, but it also is far from cheap. And since ITW isn't the fastest growing company, it has to make up for its growth rate with quality and reliability to justify its valuation.

For a diversified industrial conglomerate like ITW, there are three main ways to grow earnings -- acquisitions, higher sales volume, and higher margins. ITW hasn't been that focused on acquisitions; instead, it has chosen to streamline its business to grow sales and margins.

ITW Revenue (TTM) data by YCharts

As you can see in the chart, ITW's net income is growing faster than its revenue growth. Anytime you see that happen, it's usually due to margin expansion. After all, 24.9% revenue growth in three years isn't special. But what is special is moderate sales growth paired with a record-high operating margin.

ITW Operating Margin (TTM) data by YCharts

In the third quarter, ITW booked its highest-ever quarterly operating margin of 26.5%, bringing the trailing-12-month operating margin above 25% (also a record high). That means ITW is pocketing a quarter in operating income for every dollar in sales. For context, Apple (AAPL -0.35%), one of the world's most well-run and powerful companies, has an operating margin of 29.8%.

Focusing on margins

Efficiency, rather than sales growth, is ITW's primary focus. By 2030, the company's goal is to have a 30% operating margin and 9% to 10% average annual earnings-per-share growth, increase the dividend by 7% per year, and have 4% average annual organic growth. Low organic growth, paired with margin expansion, gives ITW plenty of earnings growth to support dividend growth and buybacks.

Speaking of buybacks, ITW has reduced its outstanding share count by 27.1% over the last 10 years. Apple, which is known for aggressively buying back its stock -- has reduced its share count by 35.5% over the last 10 years. But Apple's dividend has grown only 120.3% compared to 233.3% for ITW. Given that Apple is known for strong margins and buybacks, it's impressive to see an industrial conglomerate in the same league as Apple regarding strong margins and buybacks.

One of the reasons ITW has been so successful is that it treats each of its business segments almost like an individual company, giving them the freedom and flexibility to take risks while supporting them with the strength of the overall company. In its 2023 investor day presentation, ITW broke down its operating margins by segment compared to its major market peers. And according to ITW, it has higher margins than the competition in every single category.

Data source: Illinois Tool Works.

When a company is that far above average, chances are it has to do with the culture. And while many big companies talk a big game when it comes to culture, it's clear that ITW continues to do something right. Put another way, ITW's products aren't simply better than the competition in every case; the company itself is just a better-run organization.

ITW is a top-notch Dividend King

In August, ITW raised its dividend for the 53rd consecutive year to an all-time high of $1.40 per share per quarter. But even so, ITW doesn't have the highest yield at 2.2%.

ITW isn't a stock worth buying solely for the dividend. Rather, ITW is unique because it does pretty much everything investors could ask for. It operates a strong business, maintains a healthy balance sheet, and directly rewards shareholders with buybacks and dividends. And unlike other Dividend Kings for which the dividend is the main focus, ITW has been an excellent stock to own for years, even if it didn't pay a dividend. Yes, the returns have been that good.

Add it all up, and ITW remains an excellent Dividend King that could certainly keep going higher in 2024.