Given its torrid growth in 2020 and 2021, it’s hard to believe that United Parcel Service (UPS) stock is down over the past three years. But fundamentals have been declining. And there are questions about whether the company’s margin expansion is sustainable or if it was just a result of a pandemic-induced boost.

UPS is in for a challenging 2024. Even so, it stands out as my top high-yield dividend stock to buy next year. Here’s why.

Investing in long-term growth
The greatest challenge in valuing a stock like UPS is separating its lasting improvements from its cyclical performance. Looking at recent numbers, there’s no denying that UPS benefited from a surge in consumer goods spending and package delivery demand from the pandemic. At least part of its outsize gains were a one-time windfall.

But for years now, UPS has been making meaningful improvements to its logistics, routes, and operations. It has also been expanding its engagement in healthcare, automotive, and small and medium-sized businesses (SMBs). The proof is in the numbers. UPS’ digital access program for SMBs, paired with its healthcare segment, are expected to earn $2.7 billion more in 2023 revenue than in 2021 even though overall revenue is expected to decline by over $5 billion.

That’s a telling statistic that some of UPS’ growth is more permanent and not simply a benefit of the cycle. And that its long-term investments are partially offsetting cyclical challenges.

UPS is globally diversified
The biggest mistake UPS investors are making is assuming that all of its post-pandemic growth was temporary and that the company will revert back to 2019 levels. In reality, the company has done an excellent job of using its outsize 2020 and 2021 gains to improve the foundation of its business and make it more resilient to cyclical downturns.

UPS has earned more net income in the first three quarters of 2023 than in 2019 or 2018. And that’s even when considering the company has cut its full-year guidance as growth is decelerating faster than expected.

UPS generates the majority of its revenue from its U.S. domestic segment. But its operating profit distribution may surprise you. In the third quarter of 2022, UPS generated $24.1 billion in revenue (63.6% of which was from the U.S.) and $3.1 billion in operating profit — 53.5% of which came from the U.S. In Q3 2023, UPS made $21.1 billion in revenue (64.9% from the U.S.) and just $1.34 billion in operating profit — with just 42.5% of operating profit from the U.S.

The takeaway is that the U.S. domestic segment is a lower-margin business relative to the company’s international business and usually its supply chain solutions segment, too. So make sure not to read too much into U.S. cyclical trends, particularly delivery volumes, since U.S. residential deliveries are the company’s lowest-margin business.

A very attractive dividend
On its third-quarter earnings call, UPS said it is on track to pay about $5.4 billion in dividends this year. For comparison, UPS paid $5.1 billion in 2022 dividends but just $3.4 billion in 2021 dividends. Ten years ago, in 2013, it paid $2.3 billion in dividends.

Even if UPS endures a period of low growth in the short term, the stock is now in a completely different category than in years past, given how high the dividend is. There’s only so far the stock can go before the yield becomes too attractive to ignore for such a high-quality business.

Even now, UPS is up over 21% from its 52-week low. And yet, the stock still yields 4.1% — which is higher than the risk-free 10-year Treasury rate of 3.9%.

For investors who are willing to take on a little bit of risk, investing in UPS stock for essentially the same yield as the risk-free rate, but with added exposure to the potential upside (and downside) of the stock market and economic growth, makes a ton of sense. After all, UPS benefits from long-term e-commerce trends. And the stock is dirt cheap at a mere 16.4 price-to-earnings (P/E) ratio. Even if UPS’ earnings decline in 2024, it would take a major disappointment for UPS to even come close to the S&P 500 P/E of 26.3.

Simply put, UPS is too good of a company with too cheap of a valuation and too high of a dividend yield to pass up.

Charting a path toward sustained growth
There are a couple of key attributes to look for when searching for a quality cyclical company. The first is the ability to endure a downturn by supporting growth projects, operations, and dividends with cash while maintaining a strong balance sheet. Another quality to look for is where the company lands on the other side of the cycle.

Ideally, investors want to see something of a smoothed-out staircase — with flat or slight declines during downturns followed by “higher highs” during the next growth cycle.

In the case of UPS, the company has what it takes to manage a downturn and achieve new heights when the cycle improves. CEO Carol Tomé has consistently emphasized the company’s long-term investments on earnings calls, and that many of these investments may take a while to pan out but will ultimately benefit the company and its shareholders.

UPS stands out as the perfect dividend stock to own in 2024 because the dividend is a sizable incentive to hold the stock through periods of volatility, while there’s also the chance the business rebounds faster than expected, and the market rewards patient investors.

— Daniel Foelber

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Source: The Motley Fool