For more than 150 years, Watts Water Technologies(NYSE: WTS) has provided plumbing, heating, and water quality solutions. Now home to one of the broadest arrays of products serving the residential, commercial, and light industrial industries, Watts has morphed into an unstoppable-looking dividend stock.
Delivering a total return of 1,810% since Jan. 1, 2000, the company has more than tripled the returns of the S&P 500 index.
Despite this incredible run, Watts may prove still to be early on its journey to providing outperforming returns to investors over the long haul. Here's why.
Slow and steady wins the race for this serial acquirer
Watts Water Technologies classifies its products into four categories:
- Residential and commercial flow control and protection (56% of sales in 2023): These products include backflow preventers, water pressure regulators, leak detection and protection devices, commercial washroom solutions, and emergency safety equipment. Many of these products are now "smart" and connected to customers' building management systems, allowing for alerts and up-to-date information.
- Heating, ventilation, and air conditioning (HVAC) and gas (29% of sales): Includes boilers, water heaters, under-floor heating systems, alternative energy control systems, and flexible stainless steel connectors.
- Drainage and water reuse (10% of sales): Consists of drainage products, rainwater harvesting solutions, and connected roof drain systems.
- Water quality (5% of sales): This category's core products are filtration, monitoring, conditioning, and scale prevention systems.
Generating 60% of its sales from repairs and replacements, as opposed to the other 40% for new construction, Watts has proven quite stable despite serving cyclical commercial and residential construction industries.
Making 14 acquisitions over the last decade, Watts has slowly turned into a serial acquirer, inching sales higher by 4% annually over that time. While this 4% growth isn't necessarily eye-catching, the immense profitability that the company generates from bringing new companies into the fold sets it apart from the competition.
With a consistently rising return on invested capital (ROIC) that stands 16% today, Watts has proven capable of generating outsize cash flows compared to its debt and equity. This ROIC is paramount for a company that likes to grow via acquisitions like Watts, as it highlights a sustained ability to reinvest its cash flow in new businesses.
Incorporating these new companies into its operations, Watts expands geographically while entering into new product verticals and offering innovative technologies to its customers.
Image source: Getty Images.
Why buy Watts now?
The company's high and rising ROIC is noteworthy to investors because this combination has proven to generate superior returns.
WTS Return on Invested Capital and Profit Margin data by YCharts
What makes these rising figures all the more interesting is that they coincide with Watts' boom in "smart and connected" products. Growing from a high-single-digit share of sales in 2018 to 25% in the latest quarter, these digital and software-as-a-service (SaaS) water solutions bring high-margin subscriptions that continue to push profitability higher.
To quantify just how profound of an impact these smart and connected solutions have had on the company's operations, consider the following chart.
WTS Revenue (TTM) and EPS (TTM) data by YCharts
Thanks to this improving profitability, Watts has been able to raise its dividend by 11% annually over the last five years -- yet it only uses 18% of its net income to fund these payments. Bumping its dividend up by 19% in the first quarter of 2024, the company is well positioned to continue increasing its payments for decades to come.
While the company's dividend yield may only be 0.7%, the potential growth of a dividend is often more important than its current yield. For example, since 1973, dividend growers in the S&P 500 index have returned an annualized total return 2 percentage points higher than the rest of the index on an equally weighted basis.
As Watts continues to lean into its acquisitive ways while building out its smart and connected strategy, its dividend should have ample room to continue flying higher -- especially if the company's profitability continues its skyward trajectory. Thanks to the company's successful track record of making acquisitions and the tailwinds of an increasingly connected world supporting its operations, Watts looks like an unstoppable dividend stock to buy at a market-average valuation.
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Josh Kohn-Lindquist has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Watts Water Technologies. The Motley Fool has a disclosure policy.
