Stanley Black & Decker's (SWK 0.07%) shares have declined more than 60% from their 2021 high-water mark. As you might expect, there's some bad news behind that drop. The good news is that this huge price drop has opened up an investment opportunity for turnaround-focused investors that like to buy dividend stocks when they look historically cheap. If that sounds like you, now could be a good time to examine this deeply out of favor industrial stock. 

The top level view

There is no question that Stanley Black & Decker is facing significant headwinds. The list includes a balance sheet with more leverage than normal, inflation, excess inventory built up during the pandemic, and the need to integrate acquisitions. The best way to see the impact is to look at earnings. As the chart below shows, trailing-12-month earnings peaked in 2021 and have been heading generally lower since.

SWK EPS Diluted (TTM) Chart

SWK EPS Diluted (TTM) data by YCharts

For the full 2023 year, management's guidance range for adjusted earnings is particularly disheartening. The high end is $2.00 per share, with the low end at zero. That compares to record adjusted earnings of $10.48 per share in 2021. 

Digging into some problems

While the earnings decline provides a nice top-level view of the issue, it pays to examine things a little more deeply. For example, the company has been on something of an acquisition binge since 2005, with $10 billion or so spent on repositioning the portfolio. Since that point debt has steadily increased. While the debt-to-equity ratio, a measure of leverage, has moved up and down since 2005, it currently sits at nearly twice the level it was at the start of 2005. 

SWK Debt to Equity Ratio Chart

SWK Debt to Equity Ratio data by YCharts

The caveat here is that management is aware of the issue and taking steps to address it. For example, it has been selling non-core assets and putting that cash toward debt reduction. The drop in the debt-to-equity ratio at the end of the graph above is because of these moves. You could argue that selling businesses is a bad thing, however, it is hardly unusual for a company to sell assets as it looks to reposition its portfolio. The company is rumored to be looking at more possible asset sales to speed up its debt reduction efforts. It is also worth noting that a debt-to-equity ratio of 0.83 times is not outlandishly high, though it is historically high for Stanley Black & Decker, which has normally had a ratio closer to 0.5 times, which is a fairly modest figure.

If leverage were the only issue, investors might be a bit more sanguine about the future. The need for debt reduction increases the risk of the company's other headwinds, most of which are operational in nature. One notable issue today is the aftermath of the supply chain troubles during the early days of the coronavirus pandemic. To ensure that it had products available for its customers Stanley Black & Decker increased its inventory levels, often at an elevated cost (again because of the supply chain difficulties). It is now working through that extra inventory, which is putting downward pressure on earnings. This has clearly been painful, but should be temporary.

To speed up the inventory clearing, Stanley Black & Decker has been curtailing production. On the surface that's not a difficult thing to understand, but there are negatives here, as well. When a factory produces less the cost of producing each individual product goes up. And, so, margins are likely to remain under pressure for longer, stretching out the inventory clearing process. This is a case of management taking some near-term pain to better position the company for the long term. While that is probably the right call, it doesn't change the pain.

While the company is doing this, it is also dealing with the need to pass on price increases due to inflation. While such price increases may be justified, the increases will likely make it harder to clear out the excess inventory. The excess inventory, meanwhile, could also make it harder to push through the full price increase. And, as if that weren't enough, management is also trying to streamline the business from an operational perspective and with regard to its product lineup. That includes closing factories and eliminating redundant products (for example, no longer making a simple tape measure under multiple brands). After the acquisition spree, this effort is probably overdue. But, again, it is being undertaken at a difficult time since so many other things are also happening right now and there are up-front costs associated with these decisions that are hampering financial results.

The opportunity

Given the price drop, investors are keenly aware of the bad news, leaving the stock at depressed levels. But earnings isn't the right number to use to gauge valuation, given the situation. So the price-to-earnings ratio is out, with the price-to-sales ratio and relative dividend yield being better metrics to weigh its valuation today. Revenue and dividends tend to be more consistent over time than earnings. Plus, Stanley Black & Decker is a Dividend King.

This industrial giant's dividend yield, at nearly 4% today, is near the highest levels in its history. Given the long streak of annual dividend increases, that suggests that the stock is cheap right now. This view is backed up by the price-to-sales ratio, which is near the lowest levels in the company's history. That's illustrated in the chart below.

SWK PS Ratio Chart

SWK PS Ratio data by YCharts

So there is a reason to be interested in Stanley Black & Decker stock today. But, and this is important, investors need to believe that management can turn the business around. Solid, though perhaps not perfect, execution will be vital.

Time to act

Given the weak guidance for 2023, investors may think there's no reason to rush into Stanley Black & Decker's stock. But don't wait too long, because eventually investors will realize that things are starting to get incrementally better. The company, for example, expects adjusted gross margin to begin improving in the second half of the year. All told, it's probably better to do your homework now and make a decision (even if that decision is to wait) than to put off the effort and miss the opportunity to buy a historically well-run company at a great price.