1 Top Stock You’ve Never Heard Of To Buy On The Dip

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Distributor of air conditioners and spare parts watsco (BSM 3.89%) has seen its shares falter along with the broader market this year. Although most investors may never have heard of the company, its track record of growth and defensive business model should put the stock on almost everyone’s radar. But is it a buy right now?

Knowing is half the battle

Watsco is the largest distributor of air conditioning parts in the United States. If you’ve never heard of the company before, that’s understandable. Air conditioner spare parts do not get much attention. But heat waves do. When your air conditioning goes out on scorching summer days, you call your landlord or local repairman as fast as your fingers can dial. The repair person will visit you, diagnose the problem, and order replacement parts or refrigerants from distributors like Watsco.

Image source: Getty Images.

Customers’ reliance on a comfortable environment in their homes is what enables Watsco to generate sales and profits. Around 85% of the company’s revenue comes from a steady stream of spare parts, so it stands to reason that the stock is defensive.

But it didn’t happen that way this year. Watsco’s stock was down 12% for the year at Friday’s prices, but that included a three-day rally after earnings – as of Tuesday it was down more than 20%. By comparison, the S&P500 was down 13% for the year at Friday prices.

So what was holding Watsco back? Investors might have worried about the company’s 15% revenue from new air conditioning units. New units are usually sold to newly built homes. Rising mortgage rates this year could dampen new home construction, which has already shown signs of weakening.

But in its second-quarter earnings report, Watsco told investors it achieved record revenue and operating margin of $2.13 billion and 13.5%, respectively. After a banner year in 2021, management said Watsco was doing even better, growing same-store sales (or sales growth less acquisitions and new stores) by 29%.

Buy the dip?

Watsco’s steady growth dates back much further than the last quarter. Since entering the air conditioning parts distribution arena in 1989, revenues have grown at a compound annual growth rate of 15%. More impressive is the company’s 19% growth in operating profit over the same period. This demonstration of performance in all types of economic environments should hold the attention of investors.

The company has made several acquisitions over the years, including three in 2021 alone. As a distributor, acquisitions can be seamlessly integrated into Watsco’s distribution network and increase both the geographic reach of its network and the number of parts available. The company’s strategy has increased its market share from less than 1% in 1989 to 12% to 15% today.

Its dividend has grown even faster, at a level of 21% since 1989. Watsco stock now pays a handsome annual dividend of $8.80, which equates to a yield of 3.3%. Wall Street analysts expect the company to reach adjusted earnings per share of $14.63 for 2022. Thus, the dividend should be easily covered by earnings.

Looking a little deeper, Watsco shares are trading at a forward earnings multiple of around 20, which is significantly lower than its five-year average of 27. Given the valuation and defensive nature of its business model , long-term investors can find value buying on the downside of battered Watsco shares.

BJ Cook has no position in the stocks mentioned. The Motley Fool holds positions and endorses Watsco. The Motley Fool has a disclosure policy.

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