Alan Brochstein Investigates Large-Cap Industrial Stocks
In case you haven’t been looking, General Electric (GE) has rallied an impressive 23% in 2012, rising to levels not seen since late 2008. While the stock is part Financial (GE Capital) and part Industrial, it is classified as an Industrial by Standard & Poors, the largest in the sector in terms of market capitalization.
Industrials aren’t faring nearly as well as this bellwether, with a sector return of 9.7% through October 1st. This return is well below the 14.9% price return of the S&P 500 and leaves it as the third worst-performing sector behind Utilities and Energy. The average stock has performed even worse, with a 7.9% return and a slightly lower median return. Could this be an opportunity?
Over the past few years, Industrials have performed fairly well, supported by the idea of increased exports to the emerging markets. The weakness in Europe has been a big overhang, as our ability to export there has been directly reduced, but, perhaps more importantly; the indirect impact of the European weakness has been concerns over slowing growth in emerging markets.
The market dynamics are changing rapidly, with European stocks doing much better since the European Central Bank announced its most recent plan to deal with the debt crisis. The Euro has strengthened against the dollar, and emerging markets have enjoyed improving stock markets as well. One area of concern remains: China. While China is slowing, it is still growing. Many have been expecting a large stimulus program and more aggressive monetary policy, but the Chinese authorities have been relatively slow to act.
While it’s impossible to predict what China will do and how quickly the longer-term demand created by emerging middle classes in emerging markets in Asia and Latin America will overtake these near-term concerns, I think that the early momentum we are seeing in Industrials is likely to accelerate in 2013. Perhaps now is the time to be looking more closely at the sector, especially in light of the strength in GE. With that in mind, I screened the sector (using Baseline) for some potential ideas to consider:
Here are the parameters I employed for the first screen:
· Member of S&P 500 (60 companies)
· YTD Price Return < 8% (30 companies)
· Forward PE < 13X (16 companies)
· 2012 Projected EPS Growth > 0 (14 companies)
· 2013 Projected EPS Growth > 10% (7 companies)
These stocks are the laggards. I have set the valuation bar a bit higher by forcing the PE lower, while the growth bar is a bit lower. For the leaders, here are the parameters I used:
· Member of S&P 500 (60 companies)
· YTD Price Return > 8% (30 companies)
· Forward PE < 15X (19 companies)
· Forward PE vs. 10-year Median < 1X (18 companies)
· 2012 Projected EPS Growth > 14% (4 companies)
· 2012 Projected EPS Growth > 10% (3 companies)
Here are the 10 that made the cut:
The companies that made the list aren’t recommendations. As always, you should do your own investigation before purchasing any stock.
I have sorted the list by YTD return, highlighting the outperformers of the Industrial sector in green and the underperformers in red. It’s worth noting that all but Textron (TXT) are underperforming the S&P 500.
I have also included some other data to help prioritize which of the names might merit more attention. First, note that two of the stocks, TXT and Ryder System (R) have net debt to capital in excess of 50%, while Honeywell (HON), Cummins (CMI), Dover DOV) and Jacobs Engineering (JEC) are 20% or below.
Many of these stocks have been poor performers over the past five years (highlighted in red), while others have been quite strong. Near-term underperformance in the context of longer-term strong performance can often be an opportunity. I would point to all of the names in green in this regard.
Most of these companies have had decent EPS growth over the past five years, a time in which the overall S&P 500 has seen earnings growth compound at 7%. I highlighted three that have grown in excess of 10% and two that have declined more than 10%.
Finally, in the last column, I include the industry groups. Note that many of the laggards come from “Transportation”, a sector that has been the topic of much discussion lately for its weak performance. I find it interesting that Union Pacific (UNP) is doing reasonably well, while the two other railroads, Norfolk Southern (NSC) and CSX (CSX) are lagging.
While I am familiar with all of these companies, I don’t follow any closely (i.e. not on my watchlist). I have researched HON and NSC this year and have found them both to have excellent management teams and reasonable growth strategies. I understand that NSC has been hurt by its exposure to coal after a very warm winter on the East coast.
The screens today are designed to identify some potential opportunities within a lagging sector whose leader, GE, has shown very strong price momentum. I have broken down the 60-stock Industrial sector into leaders and laggards within the sector in order to focus on some of the members exhibiting characteristics of growth and value that might make them worth investigating more closely. As always, screening is just a first step as part of a more complete investment process.
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator
Disclosure: No positions in any stock mentioned
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