Industrial Stocks with Different Risk/Reward

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If you are optimistic about a full recovery, you may want to consider backing industrials. This sector is quite diverse and ranges from equipment & components to railroads and aerospace & defense. Its strong correlation with macro trends makes it an ideal bet if you are more bullish than economists. Diversification across various industrial segments could help position your portfolio to an ideal risk/reward. Below, I review three stocks that are engaged in various industries and differing growth curves.

Emerson Electric (NYSE: EMR) Carries Good Risk/Reward

At a respective 15.3x and 13.8x past and forward earnings, Emerson is fairly cheap. It offers a 3.2% dividend yield and is forecasted for solid 9.8% annual EPS growth over the next 5 years. During the third quarter, however, the company saw slowing orders from a cautious spending environment. Worse yet, it is expecting all of the growth of the year to be in just the 1H12 and not 2H12, as originally expected. Underlying volumes for they year have been weak due to impact from floods, a weak economy, and poor strategic adaptation. To be fair, EPS of $1.11 was still ahead of consensus by $0.06.

Going forward, the macro trends are highly uncertain, but I believe that the market has still become too bearish. Yes, China has seen slower growth than originally expected, but emerging markets will still bring in faster business investments than what multiples suggested. And the backlog still looks good, while restructuring efforts are helping expand margin opportunities.

Assuming Emerson meets expectations, 2016 EPS will come out to $4.82. At a multiple of 15x, this translates to a future stock value of $72.30. Discounting backwards by 8% yields a present value in-line with the current market assessment. When you factor in the dividend yield, this makes for better risk/reward than what popular opinion has suggested.

Honeywell (NYSE: HON), United Technology (NYSE: UTX) Not Overvalued But No More Than A "Hold"

Aerospace & defense stocks have been hit by the Romney loss. The reason for this is that, with greater Democrat control of fiscal cliff discussions, there is likely to be a greater amount of spending cuts in defense than if there was Republican control. But the market, surprisingly has fallen slightly more since President Obama was re-elected: while United and Honeywell depreciated by 2.2% - 2.3%, the S&P 500 depreciated by 2.8%. I believe that the market has been reasonable about factoring in the downside from defense cuts.

Honeywell and United both trade at 12.4x forward earnings - a decent discount to market levels. Analysts rate the two companies favorably with a consensus of around a "buy." United is forecasted for 11.9% annual EPS growth over the next half decade, which is 100 bps less than what is forecasted for Honeywell. The latter, however, has a slightly better financial position with a quick ratio of 1.1.

Assuming Honeywell meets expectations, 2016 EPS will come out to $7.12. At a multiple of 15x, this translates to a future stock value of $106.85. Discounting backwards by 10% yields a present value of $66.35, which is at less than a 10% premium to the current market price. Considering that the stock is relatively near its 52-week high after rising 28% from the low, I don't believe that it is attractive time to get in the stock. With that said, Honeywell has beaten expectations consistently over the past 5 quarters by an average beat of 5.2%. United has beaten expectations in 4 of the last 5 quarters.

I am also optimistic about how Boeing and Airbus's large backlogs will help stabilize the aerospace industry amidst headwinds. Particularly for Honeywell, with exposure to the Dreamliner 787 and jumbo 747-8, investors have a sustainable stream of income from this segment to look forward to. The integration of Thomas Russell in the Performance Materials / Technologies segment also helped to drive double-digit growth, so investors should not get too worked up about greater capital expenditures.

While both companies are not tremendously undervalued, I think investors are mistaken if they believe operations will collapse from defense cuts. Both firms are solidly diversified and United is classified as a conglomerate. My recommendation is to "hold."


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