With the economy moving into an extremely uncertain period, it makes sense for investors to look at dividend-paying stocks with strong balance sheets that can withstand an extended slowdown. In that spirit, here's a look at a few stocks that pass their financial health tests and come with a decent dividend yield to boot.
Stocks built to withstand a slowdown
First, a few words on the metrics and filters I used to make this list. Debt to equity is a key measure of financial health, as it represents how much debt has been used to finance a company's assets, so a lower number is better. The current ratio divides a company's current assets by its current liabilities; a result of 1 or above is considered good.
The quick ratio is similar to the current ratio, but in this case it uses the company's liquid current assets (cash, marketable securities, and receivable accounts) and divides them by current liabilities. Here, again, a figure of 1 or above is considered good.
Stocks with solid balance sheets can withstand recessions. Image source: Getty Images.
I've included the price to free cash flow (FCF) multiple as a valuation metric. One could argue that price to FCF multiple of around 20 or less is good, because it means the company is currently generating 5% (or more) of its market cap in FCF. In other words, the stock could potentially have a 5% dividend yield.
The general idea here is that if the economy does enter an extended downturn, the balance sheets of these companies will help protect against downside risk. Seven companies are listed below, with three selected as being particularly attractive right now.
| Company |
Debt/Equity Ratio |
Current Ratio |
Quick Ratio |
Dividend Yield |
Price to Free Cash Flow Multiple |
|---|---|---|---|---|---|
|
Johnson & Johnson (JNJ +2.22%) |
0.5 |
1.3 |
0.9 |
2.6% |
17.9 |
|
BorgWarner (BWA 0.66%) |
0.4 |
1.6 |
1.2 |
2.6% |
10.4 |
|
Watsco (WSO +1.62%) |
0.2 |
3.4 |
1.3 |
4.2% |
17.1 |
|
Snap-on (SNA 0.41%) |
0.3 |
2.5 |
1.6 |
3.7% |
10.7 |
|
Gentex (GNTX 1.14%) |
0.0 |
5.5 |
3.9 |
2% |
14.0 |
|
A.O. Smith (AOS +0.97%) |
0.2 |
2.0 |
1.5 |
2.3% |
17.0 |
|
Cisco Systems (CSCO +1.74%) |
0.5 |
1.8 |
1.4 |
3.4% |
12.1 |
Data source: YCharts.com.
Johnson & Johnson
Johnson & Johnson's mix of healthcare businesses (consumer health, pharmaceuticals, and medical devices) makes it a byword for stability in times of economic uncertainty. Although the company is being negatively affected by the COVID-19 pandemic, the situation unlikely to have a long-term effect on the company.
On the downside, the recent first-quarter earnings report saw management lower estimates for full-year operational sales growth to a range from a 3% decline to a 0.5% increase, from a previous estimate of 5%-6% growth. However, management also said "our estimates of the COVID-19 impact assume the relative shape of the COVID-19 curve as being more of an acute shorter term impact rather than a prolonged impact." In other words, sales should bounce back in due course.
Given that the low end of the company's adjusted operational EPS guidance range of $7.65-$8.05 puts it on 19 times earnings, the stock looks like a good value on a risk/reward basis.
Watsco
This company is the largest distributor of heating, ventilation, air conditioning, and refrigeration (HVACR) equipment and parts in the U.S. Given its so-called "buy and build" strategy of acquiring smaller companies in order to build scale and geographical presence, it's essentially a play on the consolidation of a highly fragmented market. Indeed, the company's acquisition-led strategy has seen it buying 63 different HVACR distribution businesses since 1989.
As you can see in the chart below, it's a strategy that's worked very well over the last couple of decades. Watsco's business is certainly going to take a hit in 2020 from the COVID-19 pandemic. After all, servicing HVACR equipment is very difficult when social isolation measures are in place.
On the other hand, its strong balance sheet might put it in a position to acquire more distributors in times of distress. In other words, it could emerge stronger from a difficult time for the industry. Meanwhile, underlying demand to repair and replace HVACR equipment isn't likely to disappear anytime soon.
Data by YCharts
Snap-on
As a global provider of tools, equipment, diagnostics, and information systems to vehicle dealerships and repair shops, this company is primarily a play on the vehicle repair market. Clearly, it's a market that's going to be negatively affected in 2020 as people and businesses are driving less. Moreover, Snap-on's sales to vehicle dealerships are under pressure due to falling vehicle sales.
That said, given that COVID-19 will eventually be contained, highway traffic is highly likely to bounce back in due course. In addition, lower gasoline prices as a result of the collapse in the price of oil will also help drive up auto usage. That would be good news for Snap-on. Meanwhile, its strong balance sheet should help it withstand any negative pressure in 2020, and the stock is attractively priced on a FCF basis.
