My basic approach to identifying stocks to buy boils down to looking at companies with strong dividend histories and buying when they have historically high yields. There's obviously a lot more that goes into it, but the big picture is that I'm often buying great companies that have fallen on hard times. Or you might say I like fallen angels.
It can take time for an angel to get back in the air again, however, so you have to be patient. Here are three stocks I own that are still trying to earn back their wings: Hormel Foods (HRL 0.14%), Clorox (CLX -0.69%), and Realty Income (O -0.17%).
1. Hormel's list of problems is a long one
There's no point in ignoring the obvious -- Hormel has a sizable list of problems to deal with right now. For example, it hasn't been as successful as its food peers in pushing through price increases in the face of inflation. It has struggled with supply issues in its turkey business because of avian flu. The Planters acquisition has been performing well, but in a weak market for nuts.
And, more recently, the post-lockdown recovery in China hasn't lived up to Hormel's expectations. Any one problem would be a headache, but all four at one time is a disaster.
It's little wonder that the stock is down 40% from its 2022 highs despite its status as a Dividend King. But go back and look at the list more closely. Not a single issue is likely to be a permanent headwind. They all simply require time and attention to deal with, for sure, but they are manageable and likely have been dealt with before over the past five-plus decades.
Inflation is a recurring event, avian flu is just part of the business environment, a struggling product category is nothing new, and a difficult geographic market is a normal variance. With a historically high 3.5% dividend yield, Hormel continues to look attractive if you can sit tight while management muddles through the long list of fairly normal headwinds.
2. Clorox is delivering on its promises
Clorox is also a Dividend King and its nearly 3.4% dividend yield is also historically high. The problems this consumer staples icon is facing are a bit different, particularly the most recent headwind.
During the early days of the coronavirus pandemic, demand for the company's cleaning products skyrocketed. It had to bring in high-cost contract manufacturers. Demand fell as the world moved beyond the illness, leaving Clorox with elevated expenses right when a bout of rapid inflation hit. The company's margins were hammered and investors fled.
But management promised it would build back margins via cost-cutting and price increases. It has been doing just that, with gross margin inflecting higher again after a deep slump.
CLX Gross Profit Margin data by YCharts
And then there was a cyberattack on the company that overshadowed all of the progress being made. Clorox had to resort, effectively, to pencil and paper in order to run its business. But this will likely be a temporary setback as the company is quickly getting back to normal operations.
There's still time to jump aboard here before the quarterly results start to show that this headline-grabbing problem has passed.
3. Realty Income can't control interest rates
The swift rise in interest rates over the past year or so has put pressure on real estate investment trusts (REITs) like Realty Income. Although shares of this bellwether net lease REIT are starting to recover, the stock is still down around 25% from its 2022 highs. The dividend yield is currently around 5.6%, which is near the highest levels of the past decade.
There are real problems caused by higher rates. Most notably, higher interest rates increase the cost of capital, which puts pressure on the returns the company earns on its property investments. But interest rates ebb and flow over time, so this is just a normal business issue.
And property markets adjust to higher rates so that buying assets is a profitable endeavor, otherwise the sector would freeze up. That adjustment, however, can take time as sellers usually need to feel some pain before they lower prices (a debt rollover would be an example). Investment-grade rated Realty Income has the wherewithal to muddle through this rough patch.
When the industry adjusts, as it has before, Realty Income's investment returns will improve again. With annual dividend increases in each of the past 29 years, the company has successfully weathered its share of adversity and looks likely to do so again.
Ugly stocks sometimes present big opportunities
Buying when other investors are selling isn't easy. But if you dig in and think about the problems that have caused Wall Street's worry, you can sometimes find diamonds in the rough. That's how I view Hormel, Clorox, and Realty Income today. If you think in decades and not days, you might want to do a deep dive of your own here while there's still time.
