As the market has become more and more uncertain throughout this year, I’ve written more frequently about taking a more conservative, “defensive” approach to investing. There are a lot of different ways to think about being defensive when you believe market conditions are becoming more bearish. One of the things that investors have consistently shown a tendency to do when they think stock market risk is too high versus its growth potential is to shift their money into interest-bearing vehicles like bonds.
Yields on debt instruments like bonds are much lower than the potential returns the stock market usually offers, but it makes sense that if you think the stock market is going to enter a prolonged state of distress, it may be smarter to look for options with a lower risk profile. This is one of the things that triggers the “flight to quality” that often characterizes the early stages of a bear market. It also means that investors becoming more actively willing to accept the lower returns offered in exchange for the greater safety that comes from those interest-bearing investments. This is even more true for investors that start buying Treasury bonds, which are the most conservative type of debt instrument due to their backing by the full faith and credit of the U.S. government.
There is another approach that is pretty popular seems to attempt to split the difference between the ultra-conservative Treasury buying mindset and a more aggressive, or even speculative attitude that simply continues to buy stocks and hope they eventually come back that most mutual fund companies seem to start parroting when a bear market starts (it’s a long-term investment, you have to be wiling to ride it out, they say). That approach is to buy stocks that have a demonstrated history of consistent, high dividend payouts. These are stocks that may offer yields that are competitive with those offered by more conservative bonds, but that also offer the potential of long-term gains in price.
Working with any stock, no matter whether it pays a dividend or not, means that you have to be willing to accept the fact that its price is going to fluctuate depending on what the market is doing at the time. The logic with dividend stocks, however is that the fundamentals for a company are generally stronger than those seen in non-dividend paying stocks. That isn’t uniformly, or automatically true, of course, but it is also a fact that in order to pay a useful dividend, a company has to be able to manage its business, and its balance sheet effectively enough to keep the dividend payout in place and consistent. That generally suggests that dividend-paying stocks should be able to ride out long-term market fluctuations more smoothly than other stocks.
The more uncertain the market gets, the more I think you’ll start to see more and more analysts and experts start talking about high-dividend-paying stocks. I’ve noticed a pretty significant increase in this respect this year already, and if current market conditions persist, I expect that talk to simply increase. I’ve always liked working with dividend-paying stocks; I think the passive income they offer is like picking low-hanging fruit from an apple tree, because all you have to do to bring it in is to hold the company’s shares. Those payouts act as a useful income source, but also serve to lower your effective cost basis in a stock, which is another reason dividend stocks tend to be more resilient in bearish market conditions; the dividends make it easier for those stocks to eventually rally back to a breakeven price for you, while the underlying fundamental strength can often provide a stronger springboard for the stock to rally back above the price you bought the stock at when the market recovers.
CLX is an example of a stock that pays a high dividend in the traditionally defensive Household Products industry; if you compare it to their stock price, which as of this writing is a little over $150 per share, its yield is a little lower than you can get from a 10-year Treasury bond at about 2.52%, but on a per-share basis it is quite attractive, at $3.84 per share. The more important question, I think about whether you should work with this stock is what you think about the company’s underlying fundamental strength and the stock’s overall value proposition. Let’s dive in.
Fundamental and Value Profile
The Clorox Company is a manufacturer and marketer of consumer and professional products. The Company sells its products primarily through mass retail outlets, e-commerce channels, wholesale distributors and medical supply distributors. The Company operates through four segments: Cleaning, Household, Lifestyle and International. Its Cleaning segment consists of laundry, home care and professional products marketed and sold in the United States. Its Household segment consists of charcoal, cat litter and plastic bags, wraps and container products marketed and sold in the United States. Its Lifestyle segment consists of food products, water-filtration systems and filters, and natural personal care products marketed and sold in the United States. Its International segment consists of products sold outside the United States. It markets some of the consumer brand names, such as namesake bleach and cleaning products, Pine-Sol cleaners, Liquid-Plumr clog removers and Kingsford charcoal. CLX’s current market cap is $19.5 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings increased 8.5%, while sales grew about 2.6%. In the last quarter, earnings increased 21% while sale improved almost 11.5%. The company also operates with a strong margin profile, since Net Income versus Revenues was 13.4% over the last twelve months, and 12.8% in the last quarter.
- Free Cash Flow: CLX’s free cash flow is relatively healthy at about $780 million for the last twelve months.
- Debt to Equity: CLX has a debt/equity ratio of 3.15. This is a high number that increased more than 30% over the last quarter, and is confirmed by the fact the company’s balance sheets shows more than $2.2 billion in long-term debt against only about $131 million in cash and liquid assets. Their balance sheet shows their operating profits are sufficient to pay their debt, but it is also a fact the company has generally poor liquidity right now.
- Dividend: CLX pays an annual dividend of $3.84 per share, which translates to a yield of 2.52% at the stock’s current price. The company started paying a dividend about ten years ago in the last quarter of 2008, beginning their dividend payout at $1.84. They have consistently increased their dividend each year since that point.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CLX is $5.67 per share and translates to a Price/Book ratio of 26.97 at the stock’s current price. That should sound very high, and the truth is that it is; my initial reaction to that ratio is to assume the stock is overvalued, but their historical Price/Book average is more than 90, which suggests that the stock could be trading at a major discount despite its outsized current ratio. I’m not willing to suggest the stock’s long-term target price could be in access of $500 per share, however given most of the stock’s solid fundamental measurements, I am willing to concede that the stock could show impressive resiliency relatively near to its current price, even if the market does turn bearish. In the long-term, I believe it is even reasonable to suggest the stock’s price could push near to the $200 level, which provides a long-term potential gain of about 30%.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The chart above outlines the stock’s movement over the past year. It’s pretty easy to see the stock’s increase since May from a low at around $113 per share, with the stock pushing now to a new 52-week high. I think CLX has benefitted over the last few months to the “flight to quality” phenomenon I mentioned earlier. That could be positive or negative; the stock would need to keep pushing to more all-time highs to offer any kind of reasonable near-term upside, while a drop below $145 could mark an important bearish turning point.
- Near-term Keys: Look for a push above $155 per share before taking any kind of short-term bullish trade seriously; the stock could be setting up for another strong push higher, but it is also only a few dollars away from a new downward trend. If the stock breaks below $145 per share, there could be a very attractive opportunity to short the stock or to start buying put options, with near-term support likely to be any where between $135 and $138 per share.