A.O. Smith Corp (AOS) currently trades at $43.82 per share. This “growth stock” is down for the year, yet it has quite the impressive 5-year chart. The company’s earnings increased at a 25% compound yearly rate across the past nine years. However, earnings for this year are likely to increase by a mere 4% as the company experiences a sales dip in China.
Unfortunately, China comprises the bulk of the company’s foreign sales. All in all, about one-third of company revenue stems from China. Furthermore, China is the primary catalyst for A.O. Smith’s growth. Let’s take a look at what the future might hold for this supposed growth stock.
A.O. Smith’s Businesses
This company makes and sells air purifiers, water purifiers, and water heaters. For a growth stock, this line of business is somewhat stagnant, especially in fully developed markets. Part of the bears’ issue with AOS is the bulk of its sales are in such developed regions of the world. The growth was supposed to stem from China where water heaters, water purifiers and air purifiers are in demand. However, as noted above, the company’s sales in the Chinese market are slowing. Thankfully, AOS executives are pivoting in an effort to diversify their customer base. The company is set to sell to the Indian market that is likely to double in size within the next decade. The question is whether AOS will be able to find its way in this new market, resuscitate Chinese sales and continue to expand into new regions.
The Good News
The AOS dividend has increased every single year for more than two straight decades. All in all, there has been about a 20% rate of increase on an annualized basis across the past decade. This is sweet music to the ears of growth investors who favor dividends. It must also be noted AOS increased by about 16% this past June. Though the stock had a pitiful May, it has rebounded quite nicely since the arrival of the warmer temperatures. If you are willing to tolerate some volatility, AOS should pique your interest.
To Trust or not Trust Short-sellers: That is the Question
Rewind time back to May, and AOS had slid about 23%. The stock’s dip was largely attributed to bearish comments made by some prominent short-sellers regarding the company’s foreign business. Bears question whether AOS will be able to continue selling to China at the same rate of growth experienced across the past decade. The fact that China’s economy has cooled off certainly is not good news for AOS. Investors are also spooked by the trade war between the United States and China that seems to have no end in sight. As a result, the stock dipped in May yet it bounced back quite nicely in June.
What About the North American Market?
AOS’s North American business is different than its market in China in that growth is fueled by replacements. It appears the company’s North American will continue to grow yet only in the single digits. To be more specific, AOS anticipates its North American market expanding in the low single digits across the foreseeable future. Prospective investors will find it interesting to know AOS leaders immediately disputed short-sellers’ criticisms of the company. In fact, company executives went as far as releasing data about its Chinese sales, business practices and adherence to GAAP accounting principles. These are all good signs for those considering an AOS stock purchase or options call.
Are China and India Enough?
It is quite possible AOS will stick to the Chinese and Indian markets. Though the North American market certainly matters, it is nowhere near as important as China and India, as both countries need the company’s products and are growing at a remarkably fast rate. Company executives insist the outlook for its products is strong in both of these countries. After all, people are willing to pay for water purifies, water heaters and air purifiers regardless of their location.
The problem with AOS’s line of business is water heaters and purifiers are not an absolute necessity. Rather, these items are considered luxuries in other markets, especially those that are still developing. The Chinese and Indians will spend on necessities before even considering a non-necessity such as an AOS water heater or purifier.
Buy, Sell or Hold?
Hold or sell. Though Wall Street bulls love to characterize AOS as a high-growth stock, the truth is the company’s products are non-essentials primarily sold in markets that are quite shaky to say the least. If the Chinese economy does not show signs of a looming rebound, and if India continues to suffer from a variety of problems, the likes of AOS will have to find even more markets to sell their offerings.
If you own AOS, consider holding or selling. Those sitting on the sidelines might find it best to avoid this supposed growth stock.