You can sum up the investment thesis for A. O. Smith (AOS 0.47%) very easily -- everyone wants hot water if they can get it. But this industrial's growth isn't coming from developed markets, where replacement of broken water heaters is the driver. It is coming from emerging markets where consumers are moving up the socioeconomic ladder and getting hot water for the first time. China was the big historical driver, and India is expected to support the next growth leg. Investors looking for dividend growth will like what they see here -- just examine the charts below.
1. A great record
Dividend growth is usually measured in two ways: the size of the increase and the length of time a dividend has been increased. A. O. Smith excels on both accounts. To start, the industrial company has increased its dividend annually for an incredible 30 consecutive years. You don't build a record like that by accident. It's perhaps even more impressive because the company operates in a cyclical industry. Simply put, the board has shown a huge commitment to returning value to shareholders via a growing dividend.
AOS Dividend Per Share (Quarterly) data by YCharts
As for the actual growth of the dividend, the annualized increase over the past decade was a huge 20% or so. To be fair, that's not a trend you can extend into the future. However, recent increases have been in the high single digits, which is quite compelling and far more sustainable over time. All in, A. O. Smith has serious dividend growth bonafides, even if it isn't the growth monster it was in the past.
2. A modest yield
Before going any further, it is important to highlight that A. O. Smith is not a high-yield stock. Its current dividend yield of around 1.8% is not impressive on an absolute basis even though it is more than the 1.6% yield you'd collect from investing in an S&P 500 index exchange-traded fund.
That said, the yield today is about the middle of the historical range for A. O. Smith, so it is probably fairly valued right now. If you have a value bias a yield closer to 2.4% would be a great deal, but it doesn't appear like buying today would be a huge mistake. Just go in knowing that dividend growth is the story, not a fat going-in yield. That said, don't underestimate the power of rapid dividend growth. In 2012 A. O. Smith's annual dividend per share was $0.18, a figure that expanded to $1.14 by 2022.
3. Rock solid
An important factor that dividend investors sometimes don't pay enough attention to is a company's balance sheet strength. In the case of A. O. Smith there's little to worry about. As the chart below shows, the company's debt-to-equity ratio is roughly 0.2 times. That appears kind of high on the chart, but that's only because A. O. Smith's debt-to-equity ratio is always so low. Indeed, 0.2 times is a leverage number that just about any company would be happy to put up.
AOS Debt to Equity Ratio data by YCharts
4. Coverage
Looking to a more common dividend metric, A. O. Smith's payout ratio spiked to an uncomfortable level in 2022. For an industrial company a 75% payout ratio would normally be a sign of trouble. It is directly tied to the earnings decline last year, which is also shown in the graph below, but you need to take both of these figures with a grain of salt.
AOS Payout Ratio data by YCharts
The company had a one-time item in 2022 (a non-tax pension settlement) that reduced earnings under generally accepted accounting principles (GAAP). If you pull out that item, adjusted earnings were up 6% year over year. Using adjusted earnings, the payout ratio would have been a far more reasonable 36%, which is more in line with the company's historical trends. Meanwhile, management is guiding to another year of growth in 2023 despite the tense global backdrop (inflation and geopolitical tensions, among other things). Thus, more dividend growth seems highly likely.
Slower, but still steady
As A. O. Smith has gained scale its dividend growth has slowed down from a truly impressive rate to "just" a good level. Dividend growth investors shouldn't get greedy, given that the company's dividend growth doesn't appear likely to end anytime soon as it looks to expand in India using a similar playbook to the one it used successfully in China. While the stock doesn't look cheap today, investors willing to pay a reasonable price for a proven dividend growth company should consider this long-term dividend winner.
