The industrial sector rose early in the year and then stumbled along with the broader market. It took a little longer for the industrial sector to gain traction and start to rebound than the S&P 500 Index, but since July, this sector has outperformed the market. Eaton Corporation plc (NYSE: ETN) has done even better, outdistancing both the S&P and Vanguard Industrials ETF. Roper Technologies, Inc. (NYSE: ROP), meanwhile, has lagged behind Eaton and only kept pace with Vanguard Industrials ETF despite posting record results. Here's why outperforming Eaton is still the better choice for investors.
Roper Technologies has been doing very well lately as it looks to shift away from asset-heavy businesses and toward an asset-light model that focuses more on software. For example, it recently reported record second-quarter results, with revenue advancing 14% year over year, organic sales up 9%, and GAAP earnings up 26% to $2.19 per share. It was a very good quarter.
In addition, during the quarter, Roper announced plans to sell its Gatan business (which makes microscope hardware and software) for nearly $1 billion. That frees up cash for acquisitions, like the purchase of PowerPlan (software for financial compliance) for $1.1 billion, which was completed in the second quarter. This furthers its progress away from manufacturing and toward software. Roper also raised adjusted earnings guidance for the full year to a range of $11.40 to $11.56, up from $11.09 to $11.32.
Eaton, which is largely focused on making things that help companies make the most efficient use of power (a largely asset-heavy business), has been doing pretty well, too, though not quite as good as Roper. The company's top line advanced 7% year over over in the second quarter, with organic growth of 7%. Earnings advanced to $1.39, up 21%. Although those numbers weren't as good as what Roper put up, Eaton is clearly doing pretty well today.
And like Roper, Eaton upped its guidance for the rest of the year. Eaton is now expecting earnings to be between $5.20 and $5.40 in 2018, a 14% jump at the midpoint over 2017's results, and $0.10 higher than its previous guidance. Backing the new projection is the fact that Eaton believes that just three of its core end markets are in the late stages of their typical business cycle, with seven in an early stage and six in a mid stage. This led management to conclude that, "We expect to see solid market growth for several years."
Eaton's positive longer-term outlook may help explain why the stock has outperformed both Roper and the broader industrial group since the sector started to pick up in July. But there's more going on here than just growth expectations.
The cheaper option
Benjamin Graham, the man who helped teach Warren Buffett how to invest, used to say that price is what you pay, and value is what you get. The general idea is that valuation matters. And right now, Roper, despite its impressive growth and shift toward a new business model, is expensive relative to both Eaton and the industrials group. Essentially, investors have priced in high expectations.
Roper's price to earnings ratio is around 30 today versus a five-year average of 28.5. Vanguard Industrials ETF's average P/E is around 18. And Eaton's P/E is roughly 12.5, versus a five-year average of roughly 16. There's no question that Eaton looks like the cheaper alternative.
The price-to-sales ratio shows a similar trend. Roper's P/S ratio is 6.5 versus a five-year average of 5.1. The P/S ratio for Vanguard Industrials ETF is 1.7. Eaton's P/S ratio is around 1.9 compared to a five-year average of 1.5. Once again, Roper looks like the most expensive option. That said, Eaton's strong relative showing since July has left it looking a little less compelling on the P/S ratio.
Looking at the price-to-book-value ratio also yields roughly the same outcome. Roper's P/B ratio is around 4.3 today compared to a five-year average of 3.6. Vanguard Industrials ETF's P/B ratio is roughly 4. Eaton's P/B ratio is around 2.3 versus a five-year average of roughly 2. Roper looks relatively expensive here versus both Eaton and its broader peer group, while Eaton looks relative cheap compared to its peers, though perhaps a little expensive compared to its own history.
Go with the better value
The end result is that Roper is doing well, but based on its valuation, investors appear to have been expecting strong results. Eaton, meanwhile, has been doing well, and it appears investors are only just catching up to the fact that its business and business outlook are improving. It's hard to call Eaton a screaming buy, but it looks like a better option than Roper today. Add in Eaton's roughly 3% yield, and it looks even more compelling since Roper's yield is a scant 0.5%. In this matchup, Eaton wins, particularly if you are an income investor.
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