Dividend stocks aren't necessarily immune from the market meltdowns. A huge market downturn typically takes most stocks down also. But there are some dividend stocks that tend to outperform most others when the market heads south.
We asked three Motley Fool investors which dividend stocks they like during turbulent market conditions. Their responses included Colgate-Palmolive (CL -0.57%), McCormick & Company (MKC 0.04%), and Enbridge (ENB -1.11%). Here's why these dividend stocks should shine when the market crashes.
Shining is this stock's chief business
Keith Speights (Colgate-Palmolive): During the last major market crash in 2008, many stocks lost more than half their value. The S&P 500 index plunged nearly 38% that year. By comparison, Colgate-Palmolive stock was a huge winner. Sure, shares of the consumer goods giant fell somewhat -- but only by 11% by the end of 2008. While shareholders of some stocks were terrified, Colgate-Palmolive investors didn't have much reason to worry.
Colgate-Palmolive is the kind of stock that shines during a market meltdown in large part because shining is the company's chief business. The company has been around nearly as long as the U.S. itself. Its products include Ajax surface cleaners, Colgate toothpaste, Murphy oil soap for cleaning wood surfaces, and Palmolive dishwasher detergent. Those are the kinds of products that people buy regardless of what the economy does.
In several respects, Colgate-Palmolive is in better shape now than it was heading into 2008. Trailing 12-month earnings are 44% higher than back then. Trailing 12-month revenue is roughly 6% higher. Colgate-Palmolive's dividend yield is 20% higher than it was in January 2008.
The only key area where the stock doesn't look quite as good as it did back then is in valuation. Colgate-Palmolive shares currently trade at 26 times earnings, around 8% higher than the stock's earnings multiple in early 2008. Still, though, this stock should continue to be a solid performer during choppy waters in the future.
A well-seasoned dividend stock
Tim Green (McCormick & Company): You wouldn't think selling spices and seasonings would be all that lucrative, but McCormick has managed to build an empire in the center aisles of the grocery store. With $4.4 billion of annual sales, gross margins above 40%, and operating margins in the low-to-mid-teens, McCormick is a prime example of how a strong brand can drive immense profits.
Shares of McCormick dropped during the financial crisis, but they held up better than the S&P 500. Revenue growth slowed down temporarily in 2009, but earnings growth continued without interruption. Per-share earnings have more than doubled since 2007, and the dividend has more than doubled as well. McCormick doesn't offer the highest yield, just about 2%, but its record of 31 consecutive years of dividend increases is beaten by only a handful of companies.
Despite these positives, there are a few things that should give investors pause. First, McCormick is an expensive stock, trading for around 25 times earnings. Second, the company's recent decision to pay $4.2 billion for the food business of Reckitt Benckiser, which includes French's and Frank's Red Hot, will be an expensive expansion of its business. McCormick expects its pro forma net sales to reach $5 billion due to the deal.
The pricey stock and a questionable acquisition will drive some investors away. But if you want a dividend stock that will hold up when times are bad, McCormick is a solid choice.
A pillar of strength when the market crumbles
Matt DiLallo (Enbridge): Canadian energy infrastructure giant Enbridge has an unparalleled resilience to the ups and downs of not only the energy market but markets in general. That's because long-term commercial agreements like take-or-pay contracts underpin 96% of its cash flow, which means Enbridge gets paid even if customers aren't using its assets. Further, 93% of its revenue comes from investment-grade clients, which adds another layer of protection for its cash flow.
Not only is Enbridge's cash flow as solid as it comes but so is the rest of the company's financial profile, starting with its investment-grade credit rating and improving credit metrics. In fact, the company's leverage ratio is on pace to fall to 4.3 times by 2019 due to the new projects it has entering service over the next few years, which will push the leverage ratio well below its 5.0 times target. On top of that, the company has a very conservative dividend payout ratio of 50% to 60% of cash flow, well below the 75% to more than 100% payout policies of most U.S. pipeline companies. Because of these factors, the company's 4% dividend appears to be on rock-solid ground. Further, Enbridge is on pace to increase that payout by a 10% to 12% annual rate through 2024, driven by the 74 billion Canadian dollars' ($59 billion) worth of fee-based growth projects it has in development.
Enbridge's stable financial profile has allowed the company to continue growing during periods of market stress. In fact, the company has increased its dividend every year since 1996, including by an 11.2% compound annual rate over the past two decades. That steady growth in good times and bad has provided investors with a remarkable 18% compound annual total return over the last 10 years, which included two very rough stretches in the Financial Crisis and the worst oil market meltdown in the past 30 years. Needless to say, Enbridge has what it takes to shine no matter what's happening in the market.