From Dogecoin to meme stocks, it can be easy to lose sight of the real headline story -- an economic recovery that is happening earlier than many of us expected.
The industrial sector, which was hit hard by the pandemic, is beginning to show signs of strength. However, there's still plenty of uncertainty as to what exactly the new normal will look like, how folks will adjust to getting back in the office, and the long-term effectiveness of COVID-19 vaccines. Dividend Aristocrats, an elite breed of S&P 500 members that have raised their dividends for at least 25 consecutive years, offer a safer alternative for investing in an economic recovery than other, more speculative assets. Some of our contributors pegged Stanley Black & Decker (SWK -0.71%), A. O. Smith (AOS -1.56%), and Illinois Tool Works (ITW 0.13%) as three of their favorites. Here's why.
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More than 50 years of rising dividends
Lee Samaha (Stanley Black & Decker): Having paid a dividend for the last 144 years and increased it for more than 50 consecutive years, Stanley Black & Decker is a favorite among dividend investors. The dividend history is a testimony to the strength of its business, and the good news is it's going to get stronger.
The company is benefitting from the surge of DIY projects created by stay-at-home measures during the COVID-19 crisis. The pandemic-related boom in power tool sales came at the right time for the company. It helped Stanley build sales of brands purchased in recent years, including Craftsman, Irwin, and Lenox plumbing and electrical tools.
However, Stanley is a lot more than just power tools. Its engineered fasteners have a long-term growth opportunity from their use on electric vehicles. For reference, automotive is the most important end market in Stanley's industrial segment. Meanwhile, its security segment will benefit from an increased awareness of the need for building security.
In addition, Stanley is about to expand sales in the lawn and garden products category in a big way. The company already owns 20% of outdoor lawnmower maker MTD, and management plans to take up the option to buy the remaining 80% in 2021. Plans are already afoot to significantly increase MTD's profit margin while integrating its outdoor products with Stanley's existing lawnmower and leaf blower offerings.
It all adds up to an impressive growth opportunity, and even though Stanley's dividend yield is only 1.3% right now, it's a pretty safe bet that the company will increase it for many years to come.
Forget landing in trouble -- getting into hot water can get you paid
Scott Levine (A. O. Smith): Find yourself standing in a steam-filled shower or soaking in a hot tub at the end of a long day? You may have A. O. Smith to thank for it; the company is a leading global manufacturer of water heaters and boilers. But if you're not relying on the company for drops of hot water, picking up shares of the company offers you the chance to benefit from a steady stream of dividends -- and maybe a DRIP as well.
One of the newer companies among the list of Dividend Aristocrats, A. O. Smith has raised its payout for 27 consecutive years. Granted, the 1.5% forward dividend yield may not have income investors champing at the bit, but the company's steadfast dedication to rewarding shareholders deserves to be recognized since the stock -- and its dividend -- has provided investors with market-beating returns over the past decade.
AOS Total Return Price data by YCharts.
Management's conservative approach to the dividend suggests that investors need not fret that they'll get burned by the company's overambitious approach to returning cash to shareholders. Over the past 10 years, A. O. Smith's payout ratio has averaged about 30%. Investors can find additional reassurance in the company's sound financial health, which suggests that the company is well positioned to maintain its investor-friendly dividend policy. Ending the first quarter of 2021 in strong financial health, A. O. Smith had a net cash position of $559 million.
While North American water heater sales may dip in 2021, management forecasts growth in foreign markets including China and India. Consequently, the company is guiding for revenue growth of about 14% in 2021. But it's not only the top line that is expected to rise. A. O. Smith also foresees EPS rising about 23% year over year to approximately $2.60 in 2021.
For those looking to add some nobility to their portfolios with A. O. Smith, today represents a good opportunity. Trading at 28.7 times earnings, the stock, after taking a cursory glance at the valuation, may seem pricey considering its five-year average P/E ratio is 26.1 Dig deeper, however, and investors will find that it's not as expensive as it seems. The stock is trading hands at 18.3 times operating cash flow, a discount to the five-year average multiple of 21.2.
At the top of its game
Daniel Foelber (Illinois Tool Works): Illinois Tool Works, commonly known as ITW, is one of those massive industrial conglomerates that you've probably never heard of but that surrounds our everyday lives. The company owns dozens of brands and makes just about everything -- from electronic components, to automated systems used in heavy construction, to food processing equipment. Over time, the company has consolidated its brands and streamlined business operations to improve profitability. The strategy has been successful, as ITW is now earning more net income from less revenue than in years past.
After a challenging 2020, the company is finally starting to see business improve. Out of its seven segments, all except automotive OEM posted higher organic growth in the first quarter of 2021 than in the fourth quarter of 2020. The company's revised guidance paints an attractive outlook for 2021 with operating margin between 25% and 26% and GAAP earnings per share (EPS) of $8.20 to $8.60. If achieved, ITW would notch its highest operating margin and EPS in company history, with EPS growing by 9% compared to its pre-COVID EPS of $7.74.
Few industrial stocks are guiding for as swift of a recovery as ITW. Strong profitability should support more dividend raises and stock buybacks. ITW is just two years away from being crowned a Dividend King. It would be just the fifth industrial to make the list.
The biggest red flag facing ITW is its valuation. If ITW achieves the midpoint of its guidance, it would still have a forward P/E ratio of around 27 -- which isn't cheap by any means. However, ITW is at the top of its game, generating gobs of profit as it reaps the benefits of its streamlined business model that's been years in the making. With a dividend yield of 2%, ITW is a top-tier industrial worth following.
