Why A.O. Smith Is a Retiree's Dream Stock

MarketsMotley Fool

If you're retired or nearing that phase in your life, then you want to invest in companies that offer safety, stability, and maybe even a little income. Growth is nice to have, but you're not necessarily looking for the next Apple. After all, you could do a lot better.

It may be difficult to believe, but shares of A.O. Smith (NYSE: AOS) have outrun those of the iPhone maker by 311% in the last decade when dividends are included. The company doesn't do something exciting like make rocket ships or mine bitcoin, but instead is a leading global manufacturer of water heaters, water filters, and air purifiers. Boring old water heaters.

Continue Reading Below

Even better, the business continues to grow stronger and more profitable every year from selling more products, not from accounting tricks other mature companies may need to rely on to nudge EPS higher. With no indications that the business will stop expanding any time soon, A.O. Smith might be considered a retiree's dream stock.

By the numbers

A.O. Smith runs a pretty well-oiled machine. It reports earnings in two segments: North America and the rest of the world. The former is a mature market that provides a steady and predictable foundation from households and commercial entities replacing water heaters and boilers, although water treatment products are also an important source of business. The latter comprises the most exciting business opportunities and is mostly carried by the Chinese market.

In contrast to North America, where most households only remember that they own a water heater when it breaks, many households in China are buying a water heater for the first time. Similarly, the company's water filtration and air purification products have gained tremendous traction in China. Households are looking to create the cleanest and safest home environment possible as the country's infrastructure (and air quality) plays catch-up. That gives A.O. Smith confidence in predicting that one of its products will be found in 180 million Chinese households by 2020. To put that in perspective, there are only 126 million households in the entire United States.

In 2017, revenue from China grew nearly 17% to over $1 billion -- an important milestone for the company. It was a solid year all around for A.O. Smith.

It's important to note two things. First, net earnings includes an $82 million charge from the recent changes in the U.S. tax code, which stemmed from a one-time charge for repatriating undistributed foreign earnings. Back that out, though, and investors can see that the business turned in a solid year of operating earnings growth.

Second, operating cash flow dropped like a rock in 2017 compared to the prior year. Management says not to worry, though, as 2016 was accompanied by several unusual transactions in the closing months that boosted cash flow. The company expects 2018 operating cash flow to be in the range of $475 million to $500 million thanks to higher earnings and better inventory management.

As it turns out, cash flow isn't the only metric expected to grow in the year ahead.

Opportunities on the horizon

Management has guided for a strong 2018. Here are some of the highlights:

  • The company plans to repurchase $135 million in shares this year, about the same as last year ($139 million).
  • The company increased its dividend 29% in January 2018 and now pays $0.72 per share annually. That's a yield of just 1.1%, but A.O. Smith has paid a dividend for 78 consecutive years and increased it for 26 consecutive years. Besides, if you purchased shares five years ago, the current payout yields 4.8%.
  • EPS is expected to fall within the range of $2.50 and $2.58, marking a 17% increase from last year's adjusted EPS performance at the midpoint.
  • A.O. Smith projects total revenue growth of 8.5% to 9.5% in 2018. For the North American segment, it expects lower water heater unit sales for the entire industry, but it expects year-over-year growth of 10% for its own water boiler sales and 50% in water treatment sales.
  • Sales in China are expected to witness year-over-year growth of 13% in 2018, while India should deliver over 40% sales growth for the second consecutive year.

In recent years, the company's incredible traction in China has been the key growth driver keeping shareholders happy. While that is expected to continue for the foreseeable future, management believes that India could represent a similar market opportunity (read: a $1 billion market) in the long run. Considering revenue in India stood at just $26 million in 2017, and is expected to grow to about $36 million in 2018, there's plenty of room for expansion -- if management is right about the opportunity. A word of caution, however: The Indian market has been notoriously difficult to penetrate thanks to antiquated laws, a lack of central planning (as is the case in China), and cultural differences. Therefore, it's entirely possible for management to be way off on its projections for the Indian market one day representing a $1 billion opportunity.

Stability and growth make this a retiree's dream stock

A.O. Smith has everything a retiree -- or any investor, really -- could dream of. The business has an impressive track record of delivering consistent and profitable growth by expanding into emerging markets. Given the incredible growth opportunities, there's no reason to believe the momentum will be stopping any time soon. A.O. Smith stock is exactly what retirees are looking for.

10 stocks we like better than A. O. SmithWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and A. O. Smith wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of March 5, 2018

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.