Updated on February 22th, 2022 by Felix Martinez
Every year, we individually review all the Dividend Aristocrats. This is because we view them as particularly appealing stocks for long-term dividend growth investors.
The Dividend Aristocrats are a select group of stocks in the S&P 500, with 25+ years of consecutive dividend increases. You can see a full downloadable spreadsheet of all 66 Dividend Aristocrats, along with several important financial metrics such as price-to-earnings ratios, by clicking on the link below:
The next Dividend Aristocrat in our 2022 series is A.O. Smith (AOS). In October 2021, A.O. Smith increased its dividend for the 28th consecutive year. According to the company, in the past five years, it has increased its dividend at a compound annual growth rate above 17%.
With a current dividend yield of 1.6%, A.O. Smith might not appeal to investors looking for high levels of income right now, such as retirees. Those looking for high-growth dividend growth, on the other hand, might find the company more attractive due to its long history of regular dividend increases.
A.O. Smith is a global leader applying energy-efficient products and solutions. It manufactures a variety of residential and commercial water heating equipment, as well as water treatment and air purification products.
The company is perhaps best-known for its water heaters. It operates in two operating segments, separated by geography:
Source: Investor Presentation
- North America (72% of sales)
- Rest of World (28% of sales)
As you can see, the company has a sizable international presence.
A.O. Smith has performed very well over the past decade, thanks largely to the steady global economic recovery coming out of the Great Recession of 2007-2009. From 2011 through 2021, sales and adjusted earnings-per-share increased 7% and 21.1% per year, respectively.
Combined with margin expansion and share repurchases, A.O. Smith’s impressive sales growth has fueled impressive earnings growth as well. Last year was a great year for A.O. Smith even with all the supply issues that every company is facing.
A.O. Smith reported its fourth-quarter earnings results on January 27th, 2022. The company generated revenues of $995.5 million during the quarter, which represented an increase of 19% compared to the prior year’s quarter. Revenue increased 19% in North America, while revenue growth was even higher in the rest of the world primarily in China, as this is the company’s biggest foreign market. Earnings-per-share of $0.87 for the fourth quarter increased 17.6% year-over-year.
For the year, sales and adjusted earnings-per-share grew by 22% and 42%, respectively. The company performed really well for the year, all things considered.
A.O.Smith has also issued guidance for 2022. The company is forecasting earnings–per–share in a range of $3.35 to $3.55, which would reflect a meaningful earnings acceleration versus 2021.
A.O. Smith’s growth catalysts in the U.S. include continued economic growth and increasing housing prices. As a manufacturer of water heating, water treatment, and air purification products, the company is reliant on a financially healthy consumer and housing market.
When home prices are rising and unemployment is low, consumers with disposable income are much more willing to invest in upgrades like new water heaters.
Outside the U.S., the company’s main growth prospects are in China and India, two key emerging markets with large populations and high economic growth.
Source: Investor Presentation
For 2022, A.O. Smith expects sales to increase by 16% – 18% year-over-year. Emerging markets such as China and India represent major long-term growth opportunities for A.O. Smith.
We expect A.O. Smith to grow earnings-per-share at a rate of 6% per year through 2027. We believe the company should be able to achieve at least this level of growth due to organic revenue growth and share repurchases.
Competitive Advantages & Recession Performance
A.O. Smith’s strong growth is due to its competitive advantages, primarily its top market share. A.O. Smith has the #1 market share in U.S. water heaters. It holds over 30% domestic residential share and over 40% of the commercial market share.
Possessing the top industry position gives A.O. Smith pricing power and high margins. In turn, this provides the company the ability to generate lots of cash flow, which enables it to invest in new product innovation.
Source: Investor Presentation
One potential risk for A.O. Smith is a recession. As a manufacturer, the company is closely tied to the health of the overall economy. It is not a highly recession-resistant business model.
Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $0.48
- 2008 earnings-per-share of $0.49 (2% increase)
- 2009 earnings-per-share of $0.57 (16% increase)
- 2010 earnings-per-share of $0.43 (25% decline)
- 2011 earnings-per-share of $0.60 (39% increase)
As you can see, the company performed very well during 2008 and 2009, the worst years of the recession. Earnings took a significant hit in 2010 but quickly recovered in 2011. Overall, the company performed exceptionally well, since it was still able to grow earnings over the course of the recession.
Valuation & Expected Returns
Based on the current share price of ~$70 and the midpoint of 2022 EPS guidance of $3.45, A.O. Smith shares currently trade for a price-to-earnings ratio of 20.3. We believe a price-to-earnings multiple target of 19 seems appropriate.
As a result, A.O. Smith seems overvalued right now. If the P/E multiple were to decline to the fair value estimate of 19, it would reduce annual returns by 2.0% over the next five years.
Shareholder returns will also be boosted by earnings growth and dividends, which together add up to 7.6% annual returns. All told, total returns are expected to be negative 5.6% per year. This is due to the elevation of the P/E multiple against our fair value estimate.
A.O. Smith is an industry-leading company. It has the top brand in its category, with compelling future growth potential. It has such a dominant market share of its industry that the company can continue to overcome short-term difficulties. Over the long term, we believe the potential growth opportunities in emerging markets are highly attractive.
While the dividend yield is on the low side, the company’s dividend growth is impressive.
However, the stock valuation has increased dramatically over the past year. As a result, we view the stock as overvalued, and a correction could result in negative shareholder returns over the next five years. Thus, we rate the stock a hold for now.
Additionally, the following Sure Dividend databases contain the most reliable dividend growers in our investment universe:
- The Dividend Contenders List: 10-24 consecutive years of dividend increases.
- The Dividend Challengers List: 5-9 consecutive years of dividend increases.
- The Dividend Champions: Dividend stocks with 25+ years of dividend increases, including those that may not qualify as Dividend Aristocrats.
- The Dividend Achievers: dividend stocks with 10+ years of consecutive dividend increases.
- The Dividend Kings: considered to be the ultimate dividend growth stocks, the Dividend Kings list is comprised of stocks with 50+ years of consecutive dividend increases
If you’re looking for stocks with unique dividend characteristics, consider the following Sure Dividend databases:
- The Complete List of Monthly Dividend Stocks: stocks that pay dividends each month, for 12 payments over the year.
- The Blue Chip Stocks List: this database contains stocks that qualify as either Dividend Achievers, Dividend Aristocrats, or Dividend Kings.
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly: