1 Magnificent Dividend Growth Stock That's Down 25% and Trading at a Once-in-a-Decade Valuation

Generating total returns of over 200% over the last decade and 4,000% since the turn of the millennium, The Toro Company (NYSE: TTC) has historically shrugged off the "cyclical stock" moniker if one zooms out on its timeline.Toro has delivered remarkably stable sales and earnings growth through the decades as a leader in mowing, snow throwing, irrigation, landscaping, and underground construction equipment.

However, cyclicality appears to have finally caught up to the company, as Toro's stock has practically moved sideways over the last three years, despite a 20% to 30% price oscillation up and down in between. The important point is, an investor who bought the stock exactly three years ago would've been in the red by about 5%.

Worse yet, its stock has dropped by 25% in 2023 alone -- propelled by a surprising 7% drop in sales in its most recently reported quarter.

So what makes Toro a magnificent dividend growth stock to consider now? Let me explain.

Continuous reinvention through acquisitions

Founded more than 110 years ago, Toro operates through two business segments: professional and residential. The professional segment, which accounts for roughly 76% of its revenue, sells equipment to golf courses, sports fields, landscapers, underground construction companies, and snow and ice removal contractors. Its residential segment provides the other 24% of sales, offering products like walk-behind mowers, zero-turn riding mowers, snow throwers, and other yard-care products like chainsaws or hedge trimmers.

While its diversified portfolio of products makes Toro interesting in its own right, how it built this diversification (and how successfully) makes it a tempting investment. Toro likes to find tuck-in acquisitions that complement or build out its existing product lines, and it has made more than 20 acquisitions over its history, including five in the last five years.

A perfect example is its purchase of Charles Machine Works for $700 million in 2019. The company was known for its underground construction equipment and Ditch Witch brand, and buying it helped Toro grow its underground and specialty construction end market from 2% of sales in 2012 to 25% in 2022.

We can measure Toro's ability to successfully integrate its acquisitions by using return on invested capital (ROIC) as our measuring stick. Comparing a company's profitability to its debt and equity, ROIC highlights how efficiently a company deploys its capital -- or, in Toro's case, how well it makes its acquisitions. Averaging a ROIC of 19% since 2000, Toro has consistently generated robust returns on the capital it has put to work.

TTC Return on Invested Capital Chart
TTC Return on Invested Capital data by YCharts.

If Toro were large enough to be in the S&P 500, its ROIC would be in the top 20% of the index -- historically an indicator of outperformance potential for stocks.

While its ROIC dipped in its most recently reported quarter, that was due to a one-time impairment charge from its most recent acquisition of Intimidator Group -- a residential-focused mowing company. This write-down of goodwill occurred as Toro saw residential sales drop by 35% in its fiscal Q3 (which ended Aug. 4) amid lower consumer confidence, drier weather, and the fact that customers haven't reached a replacement cycle on mowers bought during the earlier stages of the pandemic. Management expects these factors to all be cyclical, and merely wanted to take the pain of the write-down up front. However, it still expects the Intimidator Group acquisition to drive higher sales over the longer term.

A reliable Dividend raiser

Toro has delivered 19 consecutive years of dividend increases, and with its consistently high ROIC, there's little reason to fear it will end its streak any time soon. What makes me even more optimistic on that front is that its payout ratio is still only 37%, despite the profitability issues it faced in its fiscal Q3.

Payout ratios compare a company's dividend payments to its net income, and a mark below 50% shows an ability to continue raising its dividend for a long time. Growing its earnings per share and dividend payments by 13% and 17%, respectively, over the last decade, Toro is well-positioned to keep raising its dividend far into the future.

Best yet for investors, at the current stock price, Toro's dividend yield of 1.6% is the highest it has been since the Great Recession.

TTC Dividend Yield Chart
TTC Dividend Yield data by YCharts.

A once-in-a-decade valuation

This 15-year high dividend yield pairs beautifully with Toro's current price-to-sales ratio, which is at its lowest point since 2016.

TTC PS Ratio Chart
TTC PS Ratio data by YCharts.

This combination of a low sales multiple and a high dividend yield implies that Toro is trading at a once-in-a-decade bargain valuation. While its residential unit faces no shortage of short-term headwinds, the company's recent announcement of a partnership with Lowe's that will kick off in spring 2024 should eventually get it back on the right track.

Should the cyclical headwinds persist, Toro will likely lean into its acquisitive ways and emerge more robust than ever, primed for the next boom cycle. Based on its combination of once-in-a-decade valuations, a safe and steady dividend growth story, and a track record of success with acquisitions, Toro looks like a magnificent stock to buy now that it has dropped by 25% in 2023.

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Josh Kohn-Lindquist has positions in Lowe's Companies and Toro. The Motley Fool recommends Lowe's Companies and Toro. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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