When a stock gets beaten down by Wall Street, there's usually a good reason. The question for investors is, how permanent is the headwind? If the problems are likely to be temporary, or at least surmountable over time, a down-and-out stock could be a good long-term buying opportunity. Right now, Stanley Black & Decker (SWK -0.52%) and 3M (MMM -1.05%) are getting hammered and, for the right investors, could be worth a closer look. Here's why.
1. Another bad year ahead
Tool maker Stanley Black & Decker posted adjusted earnings of $10.48 in 2021. That fell to $4.62 in 2022 and is expected to decline again in 2023 to somewhere between breakeven and $2 per share. This is not a good trend, and investors have reacted by pushing the Dividend King's shares down 60% from their 2021 highs.
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There are a number of things going on. First, the industrial company is highly cyclical and exposed to so-called "short cycle" businesses that react quickly to changing economic environments. Stanley Black & Decker also made some acquisitions that it now has to digest, including paying off debt. Part of the process includes upfront costs to overhaul its production assets to streamline and cut out less desirable products and redundant expenses. None of the problems are going to be fixed overnight, but management is working on the things that it can control.
However, management has stated that sustaining the dividend is a top priority. That should give confidence to dividend investors attracted to the stock's historically high 3.7% dividend yield. But the long-term question is whether or not the company can overcome the challenges it faces. The last 56 years, throughout which the company increased its dividend annually, have included some very difficult operating environments, including the housing bust during the Great Recession. If Stanley Black & Decker muddled through that period in one piece and with the dividend intact, it seems reasonable to give management the benefit of the doubt today.
2. For strong souls only
It will require even more fortitude to buy 3M. The near-term problem is a slowing economy that is leading to soft financial performance. This industrial icon has long focused on innovation via research and development, so it is likely to find a path to growth again at some point. In the meantime, it should be able to run its divisions profitably through the current headwinds. All four of its business lines had solid, though perhaps not spectacular, adjusted operating margins in the first quarter of 2023. And, like Stanley Black & Decker, 3M has been through tough times before as it built up its string of 65 consecutive annual dividend increases.
So, at an operational level, 3M is probably going to be just fine. But, this time, the doghouse in which 3M finds itself includes some very severe outside stressors. For example, 3M is dealing with product liability issues around earplugs it sold to the U.S. military. And its production and use of forever chemicals have left it with legal and regulatory problems. These are not easily solved or quantified headwinds that could end up being very costly, even if 3M "wins" in the end.
It's little wonder that the stock is now down roughly 60% from its 2018 highs. Its 5.6% dividend yield, meanwhile, is at the top of the company's historical yield range and even higher than it was during the Great Recession. Only investors with strong stomachs should be looking at 3M, noting that handicapping court outcomes is very hard to do. Then there's the fact that 3M is shaking up its business with plans to spin off its growth-oriented healthcare division. That is highly likely to involve a dividend cut at 3M, given the size of the spinoff.
Other large companies have muddled through legal headwinds, so it isn't unreasonable to expect 3M to manage the same feat. And long-term dividend investors willing to take on what is basically a special situation stock at this point may find today's low price very attractive. Meanwhile, other companies doing big spinoffs have usually focused on keeping the combined dividend payments at the previous level. Just go in knowing that uncertainty is high right now. Still, the upside opportunity available if the company navigates the current headwinds is probably quite large.
Risk versus reward
Both Stanley Black & Decker and 3M are down and out today. Stanley's problems are more transitory in nature and appear easier to manage, making this out-of-favor stock the lower-risk option of the two. The legal and regulatory headwinds 3M is dealing with will probably take longer to fix and are going to involve a major corporate overhaul. It's a special-situations play right now, but one that could have material long-term appeal assuming it gets through this difficult period in relative stride. All in, both look historically cheap for the right kind of investors.
