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Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sometimes the market takes a short-term view of a situation and this can give investors a chance to pick up shares in good companies at a discount. On a regular basis, I keep up with around 200 companies to watch for opportunities where the market marks down the shares into bargain territory. One way investors can find these opportunities is by using the Fool.com CAPS Screener. When I see a stock down 20% from its 52 week high, I believe there might be opportunity. I recently ran a screen looking for large cap industrial companies that are down 20% from their high. While some would focus on the short-term global economic challenges, I believe that over time these issues will abate and industrial stocks will outperform. I expected to find multiple stocks down 20% from this screen, but it only turned up two.
Cummins (NYSE: CMI) and Caterpillar (NYSE: CAT) were the only two large cap industrial companies that met my criteria. As a provider of engines, parts and services, Cummins is a perfect play on an economic recovery. Caterpillar is another good option as the company that provides all things construction benefits directly from increased economic development. Just as a point of comparison, we'll also look at United Technologies (NYSE: UTX) as their Pratt & Whitney unit directly competes with the other two, and UTX is heavily reliant on the economy for success. Let's briefly look at each company and see what has been going on, and what investors might expect in the future.
To say that Cummins has been very successful in the last few years is a massive understatement. The company has been on a tear and even if they don't match this performance over the next few years, investors still have plenty to like at this engine maker. Cummins has actually managed to more than triple its net income over the last three years, and in that same timeframe operating cash flow has nearly doubled. Don't expect the company to stop there, as analysts are calling for EPS growth of almost 13% in the next five years. When you combine this expected growth rate, and the company's 2% yield, you get a very attractive growth and income combination. Since Cummins' free cash flow payout ratio is just 48.28%, the company should have room to continue growing its dividend. In the last four quarters, the company has repurchased shares each quarter, and currently sits on over $1.5 billion in net cash and investments. Add it all up and you have a very attractive investment. When you include the fact that shares trade for just 8.4 times projected earnings, you have a great opportunity.
Caterpillar is in a bit of a different spot than Cummins in the sense that the company is investing heavily to meet expected future demand. The fact that the company has seen negative average free cash flow in the last four quarters points to this invest first philosophy. In the most recent quarter, the company generated just $24 million in free cash flow, though they had over $16 billion in sales. However, analysts see the company growing EPS faster than their competition at about 14% in the next few years. Caterpillar is paying a 2.41% yield as well, and is one of the most well-known and well respected names in the business. If you believe that Caterpillar's investment in their future production will pay off, the stock could be a good long-term play. With shares selling for about 10 times projected earnings, shares seem somewhat undervalued relative to their expected growth rate.
United Tech. operates multiple businesses, but in the next few years there might not be a more important division than the company's Pratt & Whitney and Goodrich combination. The company took on a lot to acquire Goodrich, but this is expected to pay off by heavier involvement in the huge backlog of planes that Boeing is sitting on. At last count, Boeing had over 3,900 jets in their backlog, and United Tech. hopes to be a major provider of engines and parts to the company. The good news for investors is the company pays a 2.6% yield and is expected to grow EPS by over 12% in the next few years. United Tech. has been raising its dividend like clockwork for over 15 years. With shares selling for about 12 times projected earnings, the stock seems like a good value. The one concern that investors need to keep an eye on is the company's debt load. In the last year, United Tech.'s debt-to-equity ratio has jumped from 0.43 to 0.94, mainly due to the Goodrich acquisition. That being said, the company has generated about $1.38 billion in average free cash flow over the last four quarters so this new debt is well covered.
With two of the three above companies selling for a 20% discount to their 52 week high, investors who are sold on a global economic recovery could use this opportunity to buy in cheaper than before. Of the three companies, Cummins looks particularly attractive because of its consistent growth previously and good combination of growth and income. Caterpillar needs to show me that they can generate more consistent free cash flow before I would be comfortable investing. United Tech. is a great combination of growth and income in its own right, but the company's higher debt load is something to watch. If you want to keep up with developments at one or all three of these companies, add them to your personalized Watchlist today.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Cummins. Motley Fool newsletter services recommend Cummins. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!