Dividend Kings are S&P 500 components that have paid and raised their dividends for at least 50 consecutive years. So naturally, investors gravitate toward these stable stalwarts during times of heightened volatility, economic uncertainty, and recession fears.
In general, a company that has a track record for increasing its dividend has plenty of extra earnings and free cash flow to support that growing expense. And for that reason, these companies tend to take market share during downturns and do well during bear markets -- as investors saw with the 2022 outperformance of Emerson Electric (EMR 0.29%) and Illinois Tool Works (ITW 0.19%). However, even Dividend Kings can falter -- as was the case with Stanley Black & Decker's (SWK 0.48%) 60% decline in 2022.
Here's the case for buying Emerson Electric and Illinois Tool Works even though both companies are near their all-time highs, as well as the case for buying Stanley Black & Decker near its eight-year low.
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Emerson Electric stock deserves a valuation rerating
Lee Samaha (Emerson Electric): There's no point ignoring the elephant in the room. The industrial economy is slowing, and companies like Emerson Electric will see it in their orders in 2023. Still, much of the bad news is already priced into a stock market that declined heavily last year.
Moreover, Emerson has upside potential from its slow transition toward becoming a pure-play automation company in line with management's aims. The transition has involved divesting several noncore businesses, such as InSinkErator, and more recently, the agreement to sell the majority of its climate technologies to private equity funds managed by Blackstone.
Given that its automation peer Rockwell Automation commands a hefty valuation premium, it's reasonable to expect Emerson's stock to close the valuation gap. In addition, Emerson's investments in the complementary field of industrial software make sense -- it owns 55% of industrial software company Aspen Technology. Finally, it sets Emerson up to be a leader in process automation (technology to process raw materials) -- an excellent market, given the ongoing strength in energy prices.
As such, Emerson stands relatively well placed to deal with some uncertain conditions in the industrial sector in 2023.
Stanley Black & Decker stock has fallen far enough
Daniel Foelber (Stanley Black & Decker): While you're likely familiar with the Stanley Black & Decker brand, you may not know the stock is also a Dividend King. Stanley Black & Decker has achieved an impressive 55 consecutive years of dividend increases. But the company has been around for 180 years -- making it one of the oldest companies that is also a Dividend King.
Unfortunately, that track record does little to influence future stock performance. And Stanley Black & Decker was walloped by broader macroeconomic factors in 2022 that took a sledgehammer to its profitability by pushing operating expenses to new heights.
Since the stock fell over 60% in 2022, it certainly seems like a lot of the negative headwinds are already baked into its valuation.
Even if the company just gets back to its pre-pandemic annual net income of around $1 billion, that would bring its price-to-earnings ratio down below 13.
But if the company is able to return to normal growth during an improving economy, successful implementation of cost cuts, and a restructuring -- then its profits could very well chart a path toward steady growth and an even cheaper valuation.
All told, Stanley Black & Decker stock looks inexpensive even during a pessimistic base case and really cheap if you assume some growth for the business. Dividend Kings don't usually suffer this severe of drawdowns. When looking at Stanley Black & Decker and the stock's 3.8% dividend yield, the opportunity looks too good to pass up.
The management team of Illinois Tool Works is handy at turning shareholder capital into company profits
Scott Levine (Illinois Tool Works): With a history spanning more than 110 years, Illinois Tool Works is a leading industrials company that provides products to a variety of segments including automotive, food equipment, and welding, to name a few. Investors shouldn't dismiss the allure of this diversity. Should a downturn in one of these segments occur, Illinois Tool Works should be able to weather the storm as it operates in seven different business segments.
Those who believe that Illinois Tool Works could be a lucrative addition to their portfolios may be disappointed to find that shares aren't exactly in the bargain bin. Currently, the stock is trading at 24.8 times forward earnings, a premium to its five-year average forward earnings multiple of 22.7. But remember Warren Buffett's maxim about buying wonderful companies at fair prices.
Speaking of the Oracle of Omaha, here's another bit of his investing wisdom that applies to Illinois Tool Works: the value of the return-on-equity metric. In the 1977 letter to Berkshire Hathaway shareholders, Buffett said he believed "a more appropriate measure of managerial economic performance to be return on equity capital." And, in this regard, Illinois shines compared to its peers 3M, ABB, and Eaton.
ITW Return on Equity data by YCharts.
Over the past five years, Illinois Tool Works' management team has distinguished itself as quite adept at generating profits from shareholder capital -- a highly desirable quality for conservative investors looking to generate steady passive income.
