Industrious industrials for the gurus

Broad measures of U.S. industrial production keep improving, but some stocks in the sector stand out above others

By John Reese Dec 17, 2010 6:37PM

As the U.S.'s recovery from the "Great Recession" has progressed, one big driver of the turnaround has been the industrial and manufacturing arena. Industrial production rose in November by 0.4%, according to a new Federal Reserve report, marking the 15th time in 17 months that production has increased. And since bottoming in July 2009, the manufacturing sector has expanded for 16 straight months, according to the Institute for Supply Management.

 

As a result, industrial and manufacturing stocks -- which were hammered during the recession and bear market -- have outpaced the broader market since the March 2009 low. But, just as there's still slack in U.S. production, so too are there still bargains in the industrial and manufacturing areas. And, with government stimulus continuing to flow into the economy, consumers regaining some of their confidence, and companies having cut a lot of fat during the downturn, some of these stocks are in good position to continue rebounding.

 

Keep in mind, however, that as we get deeper into the recovery, the rising tide that may have lifted a lot of industrial/manufacturing-type stocks should lessen, and investors will likely become more discriminating about which of these stocks they buy. That means you better pay attention to fundamentals on a stock-by-stock basis. With that in mind, I recently used my Guru Strategies, each of which is based on the approach of a different investing great, to uncover some of the industrials and manufacturers that have the best fundamentals. Here's a sampling of what I found. 

 

Flowers Foods, Inc. (FLO): Based in Thomasville, Ga., Flowers operates 40 bakeries, mostly in the southern and mid-Atlantic U.S., producing a variety of breads, buns, rolls, snack cakes, and pastries. Its products, which include Sunbeam bread and Mrs. Freshley's Jumbo Honey Buns, are distributed both fresh and frozen to foodservice and retail customers.

 

Flowers ($2.4 billion market cap) gets high marks from two of my models. My Peter Lynch-inspired strategy considers it a "fast-grower" because of its 20.5% long-term earnings per share growth rate (I use an average of the three-, four-, and five-year EPS figures to determine a long-term rate.) Lynch famously used the P/E/Growth ratio to find bargain-priced growth stocks, and when we divide Flowers' 18.1 price/earnings ratio (using trailing 12-month earnings) by that long-term growth rate, we get a P/E/G of 0.88, which comes in under the model's 1.0 upper limit.

 

Another reason this approach likes Flowers is the firm's financing: The company has a debt/equity ratio of just 18%.

 

My James O'Shaughnessy-based growth model also likes Flowers, in part because it has upped EPS in each year of the past five-year period. O'Shaughnessy found that the price/sales ratio was a better indicator of future success than the P/E ratio, and this model likes P/S ratios below 1.5. At 0.95, Flowers makes the grade.

 

Reliance Steel & Aluminum (RS): One of the largest metals service center companies in the U.S., Reliance makes over 100,000 metal products that range from stainless steel to aluminum to brass to copper and beyond. The Los Angeles-based firm ($3.7 billion market cap) has a network of more than 200 locations in 38 states and countries in Asia, Latin America, and Europe.

 

Reliance gets approval from one of my best-performing strategies, the model I base on the writings of Benjamin Graham. Graham was an extremely conservative investor, and this approach requires a firm to have a current ratio (current assets/current liabilities) of at least 2.0, and more net current assets than long-term debt. Reliance's current ratio is 2.92, and it has $1.3 billion in net current assets vs. $944 million in long-term debt.

 

Graham is known as the "Father of Value Investing", so valuation was, of course, important to him. The strategy I base on his writings looks at both the P/E ratio and price/book ratio. Reliance is trading for about 14.9 times TTM earnings and 1.3 times book/value, which makes it sufficiently cheap to pass this strategy.

 

General Dynamics (GD): This Virginia-based firm is one of the U.S.'s largest aerospace & defense firms, making battle tanks and assault vehicles, armaments and munitions, battleships and nuclear submarines, and military information technology systems. The $26-billion-market-cap firm has taken in more than $30 billion in sales over the past 12 months.

 

General Dynamics gets approval from my Joel Greenblatt-inspired model. In his Little Book that Beats the Market, Greenblatt detailed a remarkably simple, remarkably successful approach that used just two variables: earnings yield and return on capital. With a 13.9% earnings yield and 57.7% return on total capital, General Dynamics is the 34th-highest-rated stock in the market, according to my Greenblatt-based model.

 

My Lynch-based model also likes GD, which it considers a "stalwart" because of the firm's moderate 14.8% long-term EPS growth rate and high sales. Lynch found that these types of big, steady firms offered protection against downturns and recessions. Since these kinds of companies often pay dividends, Lynch adjusted the "G" portfolio of the P/E/G ratio to include dividend yield when analyzing them. With its 10.8 P/E, 2.4% yield, and that 14.8% growth rate, General Dynamics has a very solid yield-adjusted P/E/G of 0.63, a sign that its shares are a bargain. In addition, the firm has a very reasonable 23.6% debt/equity ratio.

 

Hawkins, Inc. (HWKN): This 72-year-old Minnesota-based firm produces and sells 500 industrial chemicals and 600 reagent grade laboratory chemicals, which are used by everything from pharmacies to water treatment facilities to food and dairy producers to research labs, and beyond.

 

Hawkins ($500 million market cap) is another favorite of my Lynch-based model. The firm has been growing EPS at a 32% clip over the long term, and that and its 20.1 P/E ratio make for a solid 0.63 P/E/G. In addition, the company has a very strong balance sheet -- it has no long-term debt -- another reason the Lynch-based model likes it. 

 

I'm long GD and RS.

 

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