Investing in the stock market involves taking on risk to get a higher return than a risk-free asset. The objective is the same no matter the stock, but the amount of risk and potential reward can vary wildly.
Dividend Kings like Illinois Tool Works (ITW 0.66%) are companies that have paid and raised their dividends for at least 50 consecutive years. These are companies that have been around a while, operate mature businesses, and tend to reward shareholders with stock buybacks and dividends as opposed to growth. For this reason, Dividend Kings tend to be viewed as safe stocks.
But not all Dividend Kings are created equal. Some continue to raise their dividends but lack a strong balance sheet, margins, or steady free cash flow (FCF) to support dividend payments with cash.
Illinois Tool Works, commonly known as ITW, is one of the best Dividend Kings out there because it continues to deliver on its promises by running a diversified business, maintaining a strong balance sheet, returning capital to shareholders through dividends and buybacks, and growing its operating margin.
Let's go through the key reasons why ITW is a reliable and safe dividend stock to buy now.
Image source: Getty Images.
An encouraging full-year outlook
On May 2, ITW stock sold off following its first-quarter 2023 earnings announcement and proceeded to close the week down 4.8% despite a massive market rally on Friday. Even after the sell-off, the stock is still up year-to-date and is within 10% of its all-time high.
ITW reported another excellent quarter and raised its full-year earnings per share (EPS) guidance to a new range of $9.45 to $9.85. The midpoint of that guidance is lower than ITW's 2022 diluted EPS of $9.77 -- which was an all-time high. But there are plenty of other reasons to be optimistic about the company's future performance.
The industrial conglomerate has a highly diversified business across seven key segments. What makes ITW a solid overall investment is its exposure to several different industries and end markets, which helps limit the impact if there's weakness in one segment.
ITW also sports high operating margins. Q1 was no different, as ITW recorded a 24.2% operating margin thanks to operating income of $972 million which was up 9% year over year. ITW is now guiding for a full-year operating margin of 24.5% to 25.5%. If it hits that goal, it would be an all-time for the company.
Why margins matter
Operating margin is the story for ITW and a core reason why the stock has done so well in recent years. The company has done an impressive job streamlining the business by reducing redundancies and avoiding unnecessary costs. The strategy has worked, and ITW is on track to reach its long-term goal of achieving a 28% operating margin, something that very few industrial conglomerates of its size can replicate.
ITW Revenue (Annual) data by YCharts.
The above chart illustrates ITW's post-pandemic recovery thanks to margins that are far greater than pre-pandemic. Having a high operating margin means that a company is managing its operating expenses well.
Operating expenses typically include selling, general, and administrative costs; sales and marketing; research and development; and depreciation and amortization. In the pursuit of sustainable organic growth, large industrial companies often find themselves with a bloated cost structure, unnecessary expenses, and sometimes entire segments that are holding the company back.
ITW is unique because all of its business segments continuously perform well, which helps the overall business have a high operating margin despite its complexity. ITW has a higher operating margin than many of its competitors.
The following chart shows some of the largest industrial conglomerates, many of which compete with ITW in some way. Notice that the only company on this list that has an operating margin over 20% is ITW.
DOV Operating Margin (Annual) data by YCharts.
ITW rewards its shareholders
ITW's impressive operating margin is a sign that it is a well-run business. But an excellent business doesn't automatically translate to being a good stock. As Warren Buffett famously said, "Price is what you pay, value is what you get." Based on its guidance, ITW has a forward price-to-earnings (P/E) ratio of around 24. ITW is a little expensive for a company with low growth.
However, the company arguably deserves its premium valuation. Aside from being an excellent business, ITW has directly returned value to shareholders by raising its dividend and buying back a boatload of stock. In the last decade, ITW has increased its dividend by over 240% and reduced its outstanding share count by nearly a third.
ITW Dividend data by YCharts.
For context, Apple, which is famous for its stock buybacks, has reduced its outstanding share count by 37.8% and grown its dividend by 111% over the last 10 years. You would be hard-pressed to find an industrial stock of ITW's size that has bought back that much stock in the last decade.
While dividends provide a short-term benefit to shareholders, stock buybacks reduce the outstanding share count, which permanently increases earnings per share and makes ITW a better all-around value. In its Q1 2023 press release, ITW said that it plans to spend $1.5 billion in stock buybacks in 2023 alone.
The complete package
ITW has it all. It's a great business with solid fundamentals and an enviable track record for dividend raises and buybacks. However, ITW's slow bottom-line growth rate, paired with its premium valuation, are two downsides worth considering. Despite these cons, the pros are simply too good to ignore. Investors looking for a safe dividend stock to buy and hold for years to come should look no further than ITW.
