When hunting for discounted investments, one excellent starting point is to look for businesses with dividend yields trading above their five-year averages. Often, this higher-than-normal figure also means that the company's price-to-earnings (P/E) multiple has dropped over recent years, potentially indicating a more reasonable price.
Snap-on (SNA 0.20%) and Lennox International (LII 0.34%) are two companies that fit this bill, with their dividend yields roughly 50% above recent averages. Yet, they both appear to be firing on all cylinders. In fact, over the past decade, Snap-on and Lennox shares have posted market-beating total returns of 230% and 325% -- impressive considering their P/E ratios have compressed over that time to just 14 and 18, respectively.
Considering this, let's explore what makes these two businesses such great investments to add $1,000 to now.
SNA Dividend Yield data by YCharts
1. Snap-on
Providing tools, equipment, and diagnostic and information systems to its automotive, commercial, and industrial customers, Snap-on has quietly delivered total returns of over 9,000% since its initial public offering in the 1970s. However, despite this track record of success and tripling its earnings per share (EPS) in the last decade, the company trades at an attractive P/E ratio of 14 as its stock price continues to lag behind its steady results.
One thing that may be keeping this valuation somewhat compressed is the market's worries about the company's role in the ongoing electric vehicle (EV) revolution. As it generates more than two-thirds of its revenue from sales to auto technicians, mechanics, managers, and shop owners, investors may worry because of potential upheaval to that market.
However, CEO Nicholas Pinchuk believes the shift toward EVs and tech-dense automobiles will significantly benefit the company.
At an investor conference in March 2023, Pinchuk highlighted that roughly 80% of vehicle repairs are not drivetrain related, meaning movement toward EVs would not profoundly upend its customers' operations. Pinchuk explained why hand tools have continued to see recent success, stating, "With the compartmentalization of the cars, the remaining mechanical parts are even more complex and have to fit into a smaller space."
In the simplest terms, as vehicles become more complex, Snap-on stands to benefit as more parts will have to be removed first to gain access to whatever part needed to be fixed in the first place -- meaning additional or new tools may be required.
Paying a 2.5% dividend that requires only 35% of the company's net income, Snap-on will pay investors to wait as it hopefully proves that its moat in the automotive industry may be far more expansive than the market gives it credit for. Tallying 13 consecutive years of dividend increases that have grown by an average of 15% over the last five years, Snap-on's dividend history makes it a perfect buy-and-hold investment.
With the stock trading at a 20% discount compared to its historical P/E ratio of 18 across the last two decades, Snap-on's low valuation may represent an opportune time to buy this steady dividend grower.
2. Lennox International
Driven by 125 years of innovation in the heating, ventilation, and air conditioning (HVAC) industry, HVAC designer and manufacturer Lennox International has delivered total returns of nearly 4,000% since the turn of the century. These impressive gains are more than 10 times the return of the S&P 500 index over the same time frame.
However, despite posting revenue and EPS growth of 13% and 12% in 2022, Lennox's shares are roughly 30% below their all-time highs from 2021.
Now trading at just 18 times earnings, the company's valuation is well below its 10-year average of 26. But there is much more to the company than an attractive price.
First, Lennox boasts an outstanding return on invested capital (ROIC) of 42%, which means it generates outsized profitability compared to its debt and equity levels. Historically, companies with high-and-rising ROICs tend to outperform their peers, hinting that the company may have a leg up on its competition.
Just how big of an advantage does Lennox have through its stellar ROIC? Consider this chart comparing the company to three of its most significant publicly traded peers.
LII Return on Invested Capital data by YCharts
To highlight how impressive this mark is, if Lennox were large enough to be included in the S&P 500, its ROIC would be the fourth best among the 69 industrial stocks held by the index.
Furthermore, Lennox is well-positioned to continue hoovering up market share in the $50 billion North American HVAC industry. Currently accounting for less than 10% of the market, the company's long history of focusing on innovation should give it a growth advantage as the industry is tasked with creating regulatory-approved and eco-friendly HVAC units.
Generating 68% of its revenue from the residential HVAC market, Lennox should see a significant tailwind in new construction sales, with the U.S. currently undersupplied by 1.5 million to 2 million homes. However, even if this is not the case, the company generates 75% of its total sales from replacements versus 25% from new construction, demonstrating that it should remain resilient regardless of the broader economy.
Finally, the company pays a 1.8% dividend that only uses 29% of its net income. Also raising its dividend for 13 consecutive years, Lennox has posted 16% annualized dividend growth over the last five years. In addition to this dividend, the company has consistently repurchased its shares, lowering its share count by 30% over the previous decade.
Buoyed by the stability of its HVAC replacement operations and the upside from its new construction tailwinds, Lennox's growth story is the perfect combination of a fair valuation, strong profitability, and incredible cash returns to shareholders. As a result, this may be a premier stock for investors looking to buy and hold forever.
