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A.O. Smith: A Buy For Dividend Growth Investors

A.O. Smith: A Buy For Dividend Growth Investors
Piotr Trojanowski | Dreamstime.com

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Friday, 14 June 2019 11:22 AM Current | Bio | Archive

Trade tensions are rising between the U.S. and one of its biggest trading partners, China, which could mean trouble ahead for U.S. companies that generate high levels of revenue from this key emerging market.

As a result, shares of A.O. Smith (AOS) have declined 11% in the past three months. The stock has returned 7% year-to-date, underperforming the 15% return for the broader S&P 500 Index so far in 2019.

Despite the recent trade concerns, A.O. Smith remains an excellent dividend growth company. It has raised its dividend each year for over 25 consecutive years, making it a member of the exclusive Dividend Aristocrats list. For these reasons, A.O. Smith is one of the best dividend stocks to buy today.

Short-Term Concerns, Long-Term Potential

A.O. Smith is a leading manufacturer of residential and commercial water heaters, boilers and water treatment products. There is good reason for A.O. Smith investors to be concerned about a potential trade war with China. While A.O. Smith generates 64% of its sales in North America, it also generates approximately 34% of sales in China.

The company reported its first quarter earnings results on April 30. Revenue of $748 million declined 5.1% compared to the prior year’s quarter. A.O. Smith grew its revenues by 4% in North America during Q1, but at the same time, sales in the rest of the world, including China, declined by a substantial 21% compared to the previous year’s quarter. A.O. Smith produced earnings-per-share of $0.53, which represents a decline of 12% compared to the prior year’s quarter.

China is already a very important market for A.O. Smith, and is poised to become even more important in the years ahead. But investors should keep in mind that trade issues are a short-term concern. It is highly likely that the U.S. and China will sort out the recent trade dispute, leaving investors to focus on the long-term potential.

A.O. Smith has grown its earnings-per-share by 18% annually over the last decade, which is a very attractive growth rate. Such strong earnings growth was due largely to 10% annual sales growth from 2010 to 2018. While the company benefited from the booming housing market in the U.S. and stronger domestic consumer spending, China was an even bigger contributor to A.O. Smith’s growth.

Sales in China grew at an annual rate of 21% during the last decade. The company should keep growing for many years in China thanks to the country’s huge population, its robust GDP growth, and a booming middle class.

A.O. Smith: A Buy For Dividend Growth Investors

A.O. Smith has raised its dividend for 25 years in a row, making the company a Dividend Aristocrat. Its long history of dividend growth is the result of a leadership position in its industry and a high historical growth rate.

In the short-term, the growth outlook in China is challenged, due to trade worries that affect U.S.-based companies with a large exposure to China. That said, the long-term growth potential from emerging markets such as China and India is very attractive.

Based on 2019 EPS forecasts of $2.72, A.O. Smith trades for a P/E ratio of 16.7. We believe that a 20x EPS multiple would represent a fair valuation for the company’s shares, leading to ~5% annual returns over the next five years.

In addition, expected EPS growth of 9% per year and the 1.9% dividend yield leads to total expected returns of nearly 16% per year over the next five years, a highly attractive rate of return for this Dividend Aristocrat.

Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.

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Trade tensions are rising between the U.S. and one of its biggest trading partners, China, which could mean trouble ahead for U.S. companies that generate high levels of revenue from this key emerging market.
ao smith, china, worries, overblown, dividend, aristocrat
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2019-22-14
Friday, 14 June 2019 11:22 AM
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