After a scorching rebound between roughly mid-June and mid-August, the broader stock market has taken a turn as the economy begins to show signs of weakening. But there's no need to panic.
Long-term investors are no strangers to economic cycles. And in many ways, economic cycles are simply par for the course when it comes to investing over a multidecade time period.
Illinois Tool Works (ITW 0.27%), Caterpillar (CAT 1.58%), and Celanese (CE 0.72%) are three dividend stocks that are down big off their highs. Here's what makes each a great buy now.
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Illinois Tool Works is a regal dividend choice despite its recent dip
Scott Levine (Illinois Tool Works): Illinois Tool Works is a Dividend King -- a member of the S&P 500 index that has raised its dividend for 50 consecutive years or more. Despite their royal stature, shares of Illinois Tool Works -- and their forward dividend yield of 2.7% -- have fallen out of favor with investors, as shares of Illinois Tool Works are down 18% from their all-time high.
It's important to recognize, though, that the stock's decline through 2022 isn't indicative of some catastrophe that the company has suffered. In fact, the drop in Illinois Tool Works' stock isn't much steeper than the near-17% plunge the S&P 500 has experienced. Instead, the stock's fall seems to be a result of the overall bearish sentiment that has pervaded the market over the past few months as fears of an economic downturn and inflation weigh heavily on investors' minds.
But this isn't Illinois Tool Works' first rodeo. With a history of increasing its dividend to shareholders for more than 50 years, Illinois Tool Works has experience with negotiating the turbulent waters of recessions, military conflicts, and periods of inflation before -- all the while continuing to reward shareholders with a higher dividend.
Despite the headwinds facing Illinois Tool Works (and the market writ large), management remains bullish on the company's future. During its recent second-quarter 2022 earnings report, management projected the company will generate revenue of $15.4 billion to $15.8 billion in 2022. Should it achieve the midpoint of this guidance, it will represent year-over-year sales growth of 7.6%. Additionally, management forecasts Illinois Tool Works will generate free cash flow between 85% and 95% of net income -- an auspicious sign that suggests the company remains well positioned to continue hiking the dividend in the near term.
No ordinary cyclical downturn
Daniel Foelber (Caterpillar): Caterpillar stock has been under pressure lately (down 26% from its all-time high) as investors reevaluate how the business would perform if economic growth slows. But the story isn't as simple as past business cycles.
It's no secret that Caterpillar's earnings ebb and flow with the broader economy. Global growth tends to translate to increased demand for industrial output, whether that's through infrastructure spending, construction, agriculture, energy, transportation, or mining equipment.
Unfortunately, the economy seems on pace for a period of slowing growth. Rising interest rates increase borrowing costs, which makes it harder to expand as quickly. Rising interest rates are undoubtedly a headwind for Caterpillar.
The Federal Reserve is raising interest rates to cool the economy off and bring inflation down. However, Caterpillar's residential construction business and its energy and transportation division have benefited from their strong end markets. Under normal conditions, an economic slowdown could result in declining earnings for Caterpillar. What's different about this inflation-driven slowdown is that higher energy costs are a key contributor to inflation. If oil and gas prices remain high for some time, that could spur a multiyear growth cycle in oil and gas as Caterpillar's customers upgrade their fleets.
Despite this mixed bag, it's unclear how Caterpillar's business is going to perform in the short term after its record 2021. If global growth is worse than expected, oil and gas demand will fall, which could bring down prices even if supply remains constrained. The same goes for construction and commodities related to mining. Regardless of the short-term situation, Caterpillar remains the market leader in many of the industries it serves, which positions it for long-term growth. In the meantime, Caterpillar stock has a 2.6% dividend yield and has paid and raised its dividend for 27 consecutive years -- making it a reliable source of passive income no matter how the economy is doing.
A Warren Buffett stock pick
Lee Samaha (Celanese): This chemicals stock is down 37% from its all-time high, trades on just 6.2 times estimated earnings for 2022, and is owned by Warren Buffett's Berkshire Hathaway. So what's not to like about the stock?
There are a few things. For example, earnings may be fantastic this year, but no one likes to buy a cyclical stock just when its end markets turn down. Celanese makes intermediate chemicals used across a swath of industries with household and consumer spending exposure. That's great when the economy is in growth mode, and the price of its acetyl chain products (including acetic acid) is soaring, but not so good when they move the other way.
The low valuation of Celanese's stock indicates that the market thinks acetic acid prices will slump further. It's been a lousy summer for the chemicals industry, with the prices of polyethylene, polypropylene, and polyvinyl all crashing in the last few months.
That said, Buffett rarely buys stocks for the here and now. Celanese has much long-term potential due to its position as a low-cost producer and synergy opportunities from the deal to buy DuPont's mobility and materials business.
Moreover, a quick look at Celanese's history of cash flow generation suggests its dividend (yielding 2.3% at present) will be easily covered. So, while the near-term risk is obvious, Celanese will likely reward investors over the long term.
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