Just because a stock lags the broader market doesn't make it a good or bad investment. You have to dig a little deeper to find out what's going on. Here's why Stanley Black & Decker(SWK 0.65%)'s underperformance over the past year could make it a good addition to your portfolio – and why carnival (CVNA 6.98%) AND Annaly Capital Management (NLY 1.64%) is best avoided.
1. Another difficult year ahead
Stanley Black & Decker is an industrial tool manufacturer. It has a high business cycle with significant exposure to retail customers, which tends to lead to very rapid business declines.
That's exactly what happened in 2022, when adjusted earnings fell to 1TP4Q 4.62 per share from 1TP4Q 10.48 in 2021. It will also be another bad year in 2023, with management taking adjusted earnings from zero to 1TP4Q 2 per share.
There are a number of factors behind the weak earnings streak, including the impact of inflation, economic headwinds, inflated inventory levels, and historically high leverage, among other factors. Management is well aware of what it's facing and is taking steps to address the issue.
This includes actions that will increase short-term pain to improve business in the long term. For example, reducing inventory by operating factories at reduced levels, which hurts margins. Other efforts to improve long-term prospects include debt relief and cost cutting.
But the company remains financially strong and has a long history of success, including paying dividends for over 140 years. Given the stock's historically high yield of 3.5%, long-term investors should probably give management the benefit of the doubt, even though the stock has fallen more than 40% in the past year, compared with a drop of about 1.8% for the stock. S&P 500 index.
2. High debt, no gains
Carvana, a digitally focused used car retailer, had a very hot stock during the early days of the coronavirus pandemic in 2020, when people were stuck at home. Since then, the company's shares have plummeted.
In the last year alone, the stock has fallen by about 90%. There are a number of issues here that investors need to consider carefully.
For starters, Carvana has yet to turn a profit for the full year. Meanwhile, leverage (as measured by the debt-to-equity ratio) has soared in 2022, even though the company isn't covering its interest expense, which is tracked using the time-to-interest-earned ratio.
To be fair, Carvana is a young company working to expand its business, but the trends here are very concerning in a capital-intensive business (vehicles are high-cost items). Perhaps if it can find a way to at least break even, it would be worth reconsidering, but right now, Carvana isn't a good risk-reward tradeoff for most investors.
3. High volatility in dividends
Annaly Capital is a real estate investment trust (REIT), meaning it owns a portfolio of mortgages, not physical properties.
Most retail investors will think of REITs as income investments, but that's not really the case with mortgage REITs, which are better viewed as total return investments. This is an important distinction.
If you're looking to make a living from the dividends your portfolio produces, you want income stocks; if you plan to perpetually reinvest the dividends because income isn't your goal, then total return is what you're looking for. An income investor wants a steady, growing dividend. But Annaly's dividend has been on a steady downward trend for the past decade.
The fact is, its stock price has also fallen. The end result, as yield and stock price move in opposite directions, is a consistently high dividend yield, often above 10%.
But given these dividend cuts, income-focused investors would face the double whammy of lower dividends and a capital loss, given the stock's roughly $601,000 decline over the past 10 years. (By comparison, if you reinvested those large dividends, your total return is positive over the past decade.)
Annaly's share price is down about 20% over the past year, and the payout yield is an attractive 14.8%. But dividend investors should look for a more reliable income stream.
Know what you own
Just because a stock goes up or down isn't enough to determine whether it's worth buying. Stanley Black & Decker is facing headwinds, but it's doing something about them, and just as importantly, it has a long history of success behind it. It's very likely to weather the current headwinds in one piece.
The same cannot be said for Carvana, a new-to-used car dealership, which faces the deadly combination of high leverage and red ink. This is a combination that may not last long. And while Annaly is a perfect mortgage REIT, its highly volatile dividend is a warning that most dividend investors should avoid.
Ruben Gregg Brewer holds positions at Stanley Black & Decker. The Motley Fool has no position in any of the securities mentioned. The Motley Fool has a disclosure policy.
