Updated on February 6th, 2019 by Bob Ciura
At Sure Dividend, we often talk about the merits of the Dividend Aristocrats. The Dividend Aristocrats have strong brands, are consistently profitable even during recessions, and possess durable competitive advantages.
Of the 500 stocks comprising the S&P 500 Index, just 57 qualify as Dividend Aristocrats.
Each year, we review all 57 Dividend Aristocrats. The next in the series is Illinois Tool Works (ITW). Illinois Tool Works is not just a Dividend Aristocrat, it is a Dividend King as well.
The Dividend Kings are a smaller group of companies with 50+ consecutive years of dividend increases. You can see all the Dividend Kings here.
If the Dividend Aristocrats are among the best dividend growth stocks in the market, then the Dividend Kings are the “cream of the crop”. A video discussing Illinois Tool Works’ dividend safety in further detail can be seen below:
This article will discuss why Illinois Tool Works is a member of dividend royalty.
Illinois Tool Works has been in business for more than 100 years. It started out all the way back in 1902, when a financier named Byron Smith placed an ad in the Economist. At the time, Smith was looking to invest in a “high class business (manufacturing preferred) in or near Chicago.”
A group of inventors approached Smith with an idea to improve gear grinding, and Illinois Tool Works was born.
Today, Illinois Tool Works has a market capitalization of $46 billion, and generates annual revenue of more than $14 billion.
Source: Investor Day Presentation
Illinois Tool Works’ portfolio is concentrated in product segments that each hold growth potential of 2%+ above the average in their respective markets.
The overarching strategic growth plan for Illinois Tool Works is to continuously reshape its business model, when necessary. The company frequently utilizes bolt-on acquisitions to expand its reach.
At the same time, it has conducted more than 30 divestments in commoditized, low-growth product lines. Illinois Tool Works routinely trims businesses and adds new ones, to maintain a growth trajectory over time.
Judging from Illinois Tool Works’ financial results, it is clear its strategic growth plan is working just fine.
Illinois Tool Works reported its fourth quarter and full year earnings results on February 1st. For the fourth quarter, the company generated revenue of $3.58 billion, which was 1.4% less than the company’s revenues during the previous year’s quarter. This revenue decline was expected by the analyst community.
Illinois Tool Works grew its revenues from its Food Equipment business by 4% year over year, with organic growth totaling an even better 5%, the highest during the last four years. The company’s Test/Measurement Electronics segment reported a 1% revenue decline.
Despite the revenue decline that Illinois Tool Works suffered from, the company has nevertheless been able to grow its earnings-per-share at a compelling pace of 15% compared to the prior year’s quarter, to $1.83. This was possible due to a combination of higher operating earnings (due to margin growth outpacing Illinois Tool Works’ revenue decline), a lower tax rate, and the positive impact that the company’s share repurchases had on its per-share performance.
Adjusted earnings-per-share increased 10% for the fourth quarter, and 15% for 2018. The upcoming year is expected to be another good one for the company.
Source: Investor Day Presentation
Illinois Tool Works guides for earnings-per-share in a range of $7.90 to $8.20 during fiscal 2019, a projected increase of 6% at the midpoint of guidance.
Competitive Advantages & Recession Performance
Illinois Tool Works has a significant competitive advantage. It possesses a wide economic “moat”, which refers to its ability to keep competition at bay. It does this with a massive intellectual property portfolio. Illinois Tool Works holds over 17,000 granted and pending patents.
Separately, another competitive advantage is Illinois Tool Works’ differentiated management strategy.
The company has employed a management process called “80/20”. This is an operating system that is applied to every business line at Illinois Tool Works.
The company focuses on its largest and best opportunities (the “80”), and seeks to eliminate costs or divest its less profitable operations (the “20”).
At the same time, Illinois Tool Works has a decentralized, entrepreneurial corporate culture. This also sets the company apart from the competition. Illinois Tool Works empowers its various businesses with significant flexibility, to customize their own approaches to serving customers in the best way possible.
One potential downside of Illinois Tool Works’ business model, is that it is vulnerable to recessions. As an industrial manufacturer, Illinois Tool Works is reliant on a healthy global economy for growth.
Earnings-per-share performance during the Great Recession is below:
- 2007 earnings-per-share of $3.36
- 2008 earnings-per-share of $3.05 (9% decline)
- 2009 earnings-per-share of $1.93 (37% decline)
- 2010 earnings-per-share of $3.03 (57% increase)
That said, the company remained highly profitable during the Great Recession. This allowed it to continue increasing its dividend each year during the recession, even when earnings declined.
And, thanks to its strong brand portfolio, the company recovered quickly. Earnings-per-share soared 57% in 2010. By 2011, earnings-per-share surpassed 2007 levels.
Valuation & Expected Returns
Illinois Tool Works trades for a price-to-earnings ratio of 17.1. After a few years of holding an elevated valuation versus its historical average, Illinois Tool Works’ valuation has come down a bit in recent months.
In the past 10 years, the stock held an average price-to-earnings ratio of 16.9. As a result, Illinois Tool Works is currently valued right on par with its historical average valuation. A breakdown of the average price-to-earnings ratio over the past decade is below:
Note: Illinois Tool Works’ current price-to-earnings ratio is 17.1.
Illinois Tool Works is fairly valued. Aside from changes in the price-to-earnings multiple, future returns will be driven by earnings growth and dividends.
As discussed previously, we expect 8% annual earnings growth over the next five years. In addition, Illinois Tool Works stock has a current dividend yield of 2.9%.
Illinois Tool Works’ dividend is a compelling reason to own the stock over the long-term. Not only does it have a strong yield of nearly 3%, but it has also increased its dividend for 55 years in a row. It typically increases its dividend at a high rate, particularly during periods of global economic growth.
In this scenario, total returns would reach nearly 11% per year, a satisfactory rate of return for a Dividend Aristocrat.
Illinois Tool Works is a high-quality company, and an even better dividend growth stock. It has a strategic growth plan that is working well, and shareholders have been rewarded with rising dividends for over 50 years.
The stock also has an attractive dividend yield, making it an appealing choice for long-term dividend growth investors. Shares are not extremely undervalued at the moment, and it is likely the company will struggle if and when a recession occurs.
However, Illinois Tool Works has earned its place among dividend royalty.