Now that we're a few weeks into 2023, the steep sell-off of many stocks during 2022 has started to make a turn toward buying. But that doesn't take away the fact that many quality companies saw their stock prices slashed by half or more over the past year or so.
While the sell-off was wide-ranging, many Dividend Kings actually did quite well in 2022. Dividend Kings, which are S&P 500 components that have paid and raised their dividends annually for at least 50 consecutive years, have a reputation for consistency in the form of a stable and growing dividend and a business you can count on no matter the market cycle. So when a blue-chip company like Stanley Black & Decker (SWK 0.70%) sees its stock price decline by 60% in a single year, it derails the benefits of years, if not decades, of dividend payments. Bear markets aren't for the faint of heart.
It would be far easier to make the buy case for a Dividend King at the top of its game that beat the market in 2022 -- like Procter & Gamble, Illinois Tool Works, Coca-Cola, or Johnson & Johnson -- than to step in and buy Stanley Black & Decker with the stock near an eight-year low. But for those who think the worst is almost over for Stanley Black & Decker stock, the turnaround story -- along with its 3.8% dividend yield, could very well lead the stock to produce a higher total return over the next three to five years than any other Dividend King out there.
For that reason, Stanley Black & Decker stands out as my top Dividend King -- and dividend stock in general -- to buy in 2023 and hold for years to come.
Stanley Black & Decker saw a sell-off of epic proportions
I can't think of another time when a Dividend King suffered a 60% or higher drawdown in a single calendar year. Even 3M, which is down 54.2% from its all-time high, suffered those losses over a multiyear period. And while the investment thesis for Stanley Black & Decker certainly has a lot to do with the stock's decline, it's essential to put the collapse into context to illustrate the dangers of when seemingly everything goes for a Dividend King.
Consider that Stanley Black & Decker distributed a total of $40.59 in dividends per share between 2000 and 2022. But its stock fell from $188.62 per share at the beginning of 2022 to $75.12 by year's end -- a $113.50 decline.
Granted, Stanley Black & Decker stock was around $30 a share at the beginning of 2000. So investors still have a nice gain even at the current price of the stock. But the bigger issue is that for new investors who bought Stanley Black & Decker stock within the past five years, it would probably take over a decade to make up for the capital losses with future dividend payments alone -- even though Stanley Black & Decker's quarterly dividend is now a much higher $0.80 per share for a forward annual yield of 3.8%.
So while Dividend Kings can be an excellent source of passive income, that passive income alone isn't enough to heal a critical blow if the stock price takes a major hit.
Stanley Black & Decker has key issues with the business
Stanley Black & Decker is facing a multitude of challenges. The stock reached an all-time high of $225 per share in May 2021 as a surge in do-it-yourself projects and home improvements pulled forward sales. The windfall proved temporary, as the company has been dealing with shrinking profitability, restructuring, cost cuts, a weakening consumer, supply chain disruptions, and many other challenges.
Just as 2020 and 2021 were catalysts for optimism toward Stanley Black & Decker, a reverse in the business climate has had a similar impact in the opposite direction.
Like most cases, when a stock surges to the upside and collapses to the downside, the reasonable valuation is likely to be somewhere in the middle. The company has done an excellent job maintaining sales growth and is currently generating all-time high sales even though profits have reverted to pre-pandemic levels.
SWK Revenue (TTM) data by YCharts
What to watch for the business to turn around
When a well-known and trusted stock suffers the size of drawdown as swiftly as what's happened to Stanley Black & Decker, there are usually multiple things that have to change for investors to rekindle hope about the stock. For Stanley Black & Decker, I think there are three key metrics to watch more than anything else.
Stanley Black & Decker's operating expenses are at an all-time high, the business is free cash flow (FCF) negative, and total net long-term debt is beginning to decline but remains near an all-time high.
SWK Total Operating Expenses (TTM) data by YCharts
Simply put, this is unsustainable. Stanley Black & Decker has to reduce costs to improve its margin and boost profitability. It also has to be FCF-positive to pay down debt and support the dividend with cash. And if there's any hope for share repurchase, the company needs to be FCF positive for that as well.
The good news is that the company seems to be on the brink of solving all three of these problems. Debt is coming down because Stanley Black & Decker completed $3.3 billion of successful divestitures in the third quarter.
The company said it achieved positive cash flow generation in September, already reduced its headcount and inventories, is on the way toward improving gross margin, and is targeting $300 million in annual cost savings as a result of a restructuring. Lower costs and a return to positive FCF will justify further dividend raises that are supported with cash.
Image source: Getty Images.
Stanley Black & Decker has an attractive risk/reward profile
It could take time for Stanley Black & Decker's turnaround to take form. And there's every reason to be pessimistic, given how poorly the company managed the business through the supply chain challenges and inflation. So for that reason, taking a wait-and-see approach to Stanley Black & Decker is the safe choice, as long as investors realize the stock price is likely to be higher if the company begins hitting its goals and progressing on the mentioned improvements.
In sum, buying Stanley Black & Decker stock now is riskier but also offers a far higher potential reward, whereas waiting for the turnaround to take form would remove a great deal of risk but also probably result in less potential reward. The best path forward depends on your personal risk tolerance and time horizon.
But with the stock floundering near an eight-year low, 55 consecutive years of dividend raises, a 3.8% dividend yield, and 180 years of history, Stanley Black & Decker is simply too good of a brand and too compelling of a turnaround story to pass up for long-term investors looking for a deep value Dividend King to buy now.
