The stock market has been anything but calm over the past year, with the broader market falling into a bear market. Since that point the Dow Jones and the S&P 500 have floundered around quite a bit, making it hard to push the buy button on anything. However, some companies, including A. O. Smith (AOS 0.33%), have fallen deep into bear markets of their own. Here's why this particular industrial stock could be a smart buy.
Down more than the average
Over the past year the Dow Jones is down around 7.5%. The S&P 500 Index is off about 18%. And A. O. Smith's stock has fallen a far more dramatic 31%. There's been a fair amount of volatility over that 12-month span, but it is clear that A. O. Smith is lagging far behind the broader indexes, languishing deep within bear market territory.
Part of that is related to a material price gain in 2021. So you could just say the stock is giving up outsize gains, but there's more to the story here. A. O. Smith's dividend yield is at the high end of its range over the past decade. That suggests that it is relatively cheap, historically speaking. On an absolute basis, the yield is around 2.1% right now. It's better than the yield on the S&P 500 Index, but that may not get dividend investors excited in and of itself.
However, when you look at the company's dividend history, the story gets more attractive. A. O. Smith has increased its dividend annually for 29 consecutive years. That's an incredible record that puts it among elite dividend payers. Over the past decade, management has increased the dividend at an annualized rate of 20%. Recent increases have been more modest, but given the global economic backdrop that's understandable. All in, this industrial stock looks like an attractively priced dividend growth choice right now.
The backstory
This is not an exciting company when you look at its business. A. O. Smith makes water heaters and water and air purifiers. The company's business is inherently cyclical, since a material portion of its sales are to the construction market. It also has material exposure to the Chinese market (about 26% of revenues), which makes up nearly all of its business outside of North America. Roughly 30% of revenues come from outside North America.
There are a couple of notable takeaways here. First, foreign growth has been a key story for A. O. Smith and that was driven by China. As residents of that country moved up the socioeconomic ladder they wanted access to hot water. That's not likely to change, even if the growth trend slows down. This brings up India, another market management has targeted in recent years. Today it is just a tiny fraction of the company's business, but management is looking to turn it into the next growth engine. There's still a lot more growth ahead here if A. O. Smith can achieve similar success in India to what was achieved in China.
Then there's the North American segment, where replacement sales make up around 80% to 85% of the division's overall revenues. Essentially, once you have hot water you are loath to give it up. That makes North America a fairly stable business over time. But take that to the next logical step with China. As the Chinese market matures, replacement sales are likely to become increasingly important and turn that giant nation into a second reliable replacement foundation to build a growing business in India.
Down but not out
If A. O. Smith made a product that was just a fad, it wouldn't be a very attractive investment. But water heaters are no fad, they are something that you want forever once you've taken a single hot shower (one cold shower is all the reminder you need of this fact). The stock has fallen along with the market and because of global economic concerns, but the drop seems overdone given the historically high yield. It could be an interesting opportunity for dividend growth investors who think in decades and not days.
