As an investor, it's hard to step into a stock when it has fallen 40% since the start of the year and the company warns there's still more bad news to come. This is exactly the backdrop investors face with water-heater manufacturer A. O. Smith (AOS 0.98%). Despite the challenging situation, this long-time dividend payer could still be worth buying on the dip. Here's why.
A. O. Smith's situation is not that bad
The most recent bad news out of A. O. Smith is that third-quarter 2022 results will be weak. The company projects that year-over-year sales will be down 4% and adjusted earnings will fall 15%. That's definitely not good news and it seems to justify the negativity coming from Wall Street traders.
The big culprit was the company's core North American market. Typically a slow and steady performer, inventory levels were disrupted by the coronavirus pandemic and are only now starting to sort out. This put downward pressure on the company's results. The company also lowered its full-year guidance for 2022 and now expects sales growth of just 5% to 7% with adjusted earnings up about 5% at the midpoint.
The news is not exactly great, but it's also not terrible. Notably, the company just announced a 7% increase in the dividend, which suggests that management is still pretty confident about the long-term future. Note, too, that A. O. Smith is a Dividend Aristocrat, with more than 25 consecutive years worth of annual dividend increases behind it. To back the positives up, management said that it thinks the business will show sequential improvement in the fourth quarter. That suggests the third quarter is more of a blip than a long-term trend.
A. O. Smith is worth the risk
So 2022 may not be the best year, but given the long-term history here on the dividend front, long-term dividend investors probably shouldn't cut and run. New investors, meanwhile, should take a look at the dividend yield. It's hovering around 2.4% and is near the highest levels of the past decade. That strongly hints that investors have pushed the stock price down to attractive levels, historically speaking.
At its core, A. O. Smith is an incredibly boring company. It predominantly makes water heaters, with smaller operations in things like water and air purifiers. Water heaters are something Western countries take for granted, at least until you have to take a cold shower. Then you realize just how desirable hot water is and understand why North America's replacement market has historically been so stable. Indeed, few people put off replacing a broken water heater.
On the growth front, meanwhile, A. O. Smith sells its products in China and India. These are two of the largest developing markets in the world, where people rising up the socioeconomic ladder are buying hot water heaters at a rapid clip. It's a simple luxury that everyone wants (revisit that cold shower if you want to know why).
These are the giant trends that support the company's long-term future. And they aren't changing anytime soon. So, if you can think beyond a quarter or two, there's still a very good reason to like this somewhat boring industrial stock.
Ups and downs
To be fair, A. O. Smith's business is cyclical, just like many of its industrial peers. So ups and downs aren't exactly uncommon here. However, if you can recognize the strength of the long-term trend toward increased hot water use in developing nations, downturns in the stock price start to look like opportunities. And that is what's likely to be the case this time around as well.