Industrial Stocks Next? How To Sort For Winners

This is one of those markets where channeling your inner Wayne Gretzky can be a great help. The ice hockey great’s defining otherworldly skill was a knack for anticipating where the puck was headed and getting to that spot before anyone else.

Right now if you’re an investor focused on where the puck is, you’ve probably got a headache. The Federal Reserve’s decision to not start its stimulus taper is either a.) a warning sign of economic weakness or b.) a sign the Federal Reserve is worried Congress may bollix things up in the coming weeks. Or c.) both.

That’s a lot to worry about over the very near term. But what about where the puck is headed in the fourth quarter and into 2014? Short of Congress doing serious long-term damage, the expectation is that economic growth is going to accelerate.

Recent strength in the U.S. ISM Manufacturing index suggests the puck may indeed be headed for a period of increased capital spending as businesses have more confidence and demand to spur reinvestment. There’s also the ticking clock element too: capital spending has been so muted since the financial crisis there’s a need to upgrade machinery and systems that are a bit long in the tooth.

The ISM’s Purchasing Manager's Index (PMI) is at its highest level in two years. A reading over 50 is considering positive sentiment:

US Purchasing Managers Index Chart

US Purchasing Managers Index data by YCharts

That suggests the puck may be headed the way of the Industrials sector. Brad Sorensen, director of sector and market analysis at Schwab (SCHW), has an outperform rating on just two sectors over the next six months: Industrials and Technology (another beneficiary of increased corporate spending).

Industrials have in fact been having a pretty nice run of late. The Industrials Select SPDR ETF (XLI) which tracks the S&P 500’s industrial stocks, is up 27% over the past 12 months compared to 17% for the full S&P 500 index. Ever since Ben Bernanke’s late May taper talk rang the bell that that it was time to focus on more economically sensitive sectors, industrials have outperformed defensive sectors:

XLI Chart

XLI data by YCharts

Still, according to S&P Capital IQ, the average 15.8 PE ratio for the S&P 500 industrial sector based on 2013 earnings estimates isn’t much higher than the 15.6 level for the entire index. (And a lot lower than the 19.6 for consumer discretionary, and the near 18 reading for the consumer defensive and materials sectors.) Moreover, based on 2014 estimates, the Industrial sector’s 13.8 PE ratio is below the expected 14 for the entire S&P 500.

General Electric (GE) is the largest holding in the $6.9 billion Industrials Select SPDR ETF. While plenty of GE’s business comes from its industrial operations, the finance arm is nonetheless a significant contributor. In 2012, 44% of revenue and one third of General Electric profits came out of the GE Capital arm. Management has been working to refocus more on its core industrial lines -- it will reportedly spin off its consumer finance arm in 2014 -- but a pure industrial play it is not.

United Technologies (UTX), Boeing (BA), Union Pacific (UNP) and 3M (MMM) round out the top five holdings in the Industrials Select SPDR.

In a market that has been starved for top-line revenue growth, United Technologies and Boeing have managed to generate strong increases:

UTX Revenue TTM Chart

UTX Revenue TTM data by YCharts

The Leuthold Group currently ranks the Aerospace and Defense industry as an attractive segment based on valuation and price momentum.

Using the YCharts Stock Screener to drill down into the S&P 500 industrials shows Joy Global (JOY) has the intriguing combination of strong revenue growth and a very cheap valuation.

As mentioned previously at YCharts, some pretty successful value funds have been buying, or adding to, Joy Global lately.

To be clear, Joy Global is a deep value/contrarian play that presupposes a global economic pick up will eventually trigger a rise in mining activity—and thus the mining equipment Joy manufactures. If you’re focused on where the puck is, a commodity-driven stock doesn’t look terribly intriguing. If you’re looking for where the puck might be headed, Joy is a cheap stock that will benefit if the global economic pickup materializes.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  industrial stocks   money managers   

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