Dividend Kings have a special place in the stock market universe. They are companies that have increased their dividends for at least 50 consecutive years. To achieve that distinction, a company has to have had relatively consistent growth, good cost controls and strong management at a minimum. Many companies try, but today only 52 names are on that board as of this writing.
One of them is Illinois Tool Works Inc. (ITW, Financial), with 52 years of dividend increases. This chart shows that growth, which averaged 13.47% per year between the end of 2012 and the end of 2022.
On its website, the company describes itself as “a global industrial company built around a differentiated and proprietary business model.” It operates through seven segments, shown in this chart of the income statement:
The dividend currently yields only 2.28%, but those who have held the stock for the long-term have enjoyed some decent capital gains:
In addition, the company buys back its own shares, at an average rate of 1.60% per year over the past three years. Taken together, the capital gains, dividend and share repurchases have provided an attractive shareholder reward package. However, can this performance continue into the future?
Creating value
The "Illinois Tool Works Business Model" is what the company credits with its success. In its 10-K for 2022, it noted, “It is the Company's competitive advantage and defines how Illinois Tool Works creates value for its shareholders.”
When we look at the return on invested capital (ROIC) versus weighted average cost of capital (WACC), we can see how well the model worked over the past dozen years in terms of creating value for shareholders:
The model is made up of three elements: the 80/20 Front-to-Back Process, Customer-Back Innovation and its Decentralized, Entrepreneurial Culture:
Source: Illinois Tool website
The company described these three elements in its latest annual filing:
“Illinois Tool Works's 80/20 Front-to-Back process is the operating system that is applied in every Illinois Tool Works business. Initially introduced as a manufacturing efficiency tool in the 1980s, Illinois Tool Works has continually refined, improved and expanded 80/20 into a proprietary, holistic business management process that generates significant value for the Company and its customers.
Illinois Tool Works has clearly demonstrated superior 80/20 management, resulting in meaningful incremental improvement in margins and returns as evidenced by the Company's operating margin and after-tax return on invested capital. At the same time, these 80/20 initiatives can also result in restructuring initiatives that reduce costs and improve profitability and returns.
Customer-back innovation refers to the practice of innovating from customer needs rather than from the research and development center. Customer insights and learnings have contributed to a portfolio of 19,200+ granted and pending patents.
Decentralized, Entrepreneurial Culture refers to the philosophy of giving businesses significant flexibility."
The operating margin is a key component of profitability, and the company has done an excellent job of growing it since adopting its business transformation in 2012. At the end of 2012, the operating margin was 16.27%, and at the end of 2022, it had risen to 24.15%.
The gross and net margins are also industry-leading for the industrial products industry at 41.21% and 19.27%, respectively. The company has been profitable in each of the past 10 years.
Good profitability should also provide free cash flow, which the company can use to initiate new growth, as well as pay dividends and buy back shares. However, that hasn’t been the case for the past three years, nor in 2014:
A turnaround in free cash flow may be in the making, though. In its first quarter 2023 earnings release, Illinois Tool Works announced that free cash flow had jumped to $615 million, an increase of 147% year over year.
What about the bottom line? It has been on an upward trajectory since 2014, with a couple of bumps along the way.
Gurus and insiders
At the end of the first quarter of 2023, 10 gurus held positions in Illinois Tool Works Ken Fisher (Trades, Portfolio) of Fisher Asset Management had by far the biggest stake, with 2,377,957 shares, representing 0.78% of the company's shares outstanding and 0.35% of the firm's 13F holdings.
The 13F filings also tell us Tom Gayner (Trades, Portfolio) of Market Gayner Asset Management held 327,500 shares and Joel Greenblatt (Trades, Portfolio) of Gotham Asset Management held 26,436 shares.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Neither institutional investors nor insiders have significant holdings. Institutional investors have a stake of just 44.77%, while insiders own 0.54%. E. Scott Santi, the Chairman and CEO, had the biggest stake among insiders, with 225,217 shares.
My take
All in all, I think Illinois Tool Works is a powerful company with three top-notch qualities that investors like. It has a tested and proven business model that has enhanced its growth and helped control its costs. That helps produce a high level of profitability. Its 52-year history of dividend increases suggests the company has remained committed to generating profitable growth for over half a century.
