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Eaton Corp. (NYSE:ETN) operates in diversified electronic industry and provides energy efficient solutions to its customers in order to assist their businesses. The electric components industry has been subject to some serious risk factors as bigger clients move towards other new resources of energy. In this situation, Eaton attains its strength by pursuing a portfolio, which is diversified across industries. At the same time, regional diversification is also at play. Over the years, the company has established a strong business model. Despite the strong risk factors, the stock price has shown appreciation and the growth prospects have been kept alive by adapting a number of different growth strategies. The company has been involved in a number of acquisitions, which have helped the company in developing its diversified portfolio. The industry as a whole is facing difficult circumstances and this poses sizable risks to the future prospects of the company but at the same time, the company's strengths provide strong potential for future growth, which also needs to be considered. Based on this risk-return paradigm, this analysis will evaluate Eaton as a prospective investment opportunity for equity investors.

Revenue Profile and Stock Performance

The portfolio of Eaton has undergone substantial changes over the years. Firstly, in FY00, approximately 80% of the company's operations were conducted in the U.S. and the revenues from developed and emerging countries were limited to 10% each. Similarly, the automotive and truck segments used to be a major part of the company's product portfolio. This has changed substantially in the last 12 years in favor of the electrical segment.

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Source: Annual Report 2012

The above chart shows the division of the company's total revenues according to regions and business segments as obtained in FY12. The chart shows that the company's revenues have shifted away from the U.S. in the favor of other developed and emerging markets. This can be seen as a major source of growth as the company has attempted to tap into the global demand for its products and at the same time, it has substantially decreased its region specific risks. Similarly, the segment information shows that the company's product portfolio has increased in the favor electrical components as the segment contributes to approximately half of the company's revenues.

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Source: YCharts

The above chart shows the change in stock price of the company as compared to the S&P 500 index over a period of one year. In this chart we see that the company has outperformed the upward trend of the market as the stock price has shown an appreciation of 56.4% whereas the index has only increased by 26%. This increase in stock price has been primarily driven by the aggressive growth strategy pursued by the company in recent years.

Financial Performance and Growth

The company's financial performance has been fairly erratic over the recent years due to a number of factors but overall, the company has been able to post a substantial growth in revenues and earnings.

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Data Source: Morningstar

The above chart shows the income statement statistics of the company in the past four years. The chart clearly shows how the overall sales and the company's earnings have improved in these years. The net profit margin showed a sizable improvement until FY11 before marginally declining in FY12.

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Data Source: Morningstar

The above chart shows the total assets and cash outflow from investing activities over the last four years. The chart evidently suggests a boost in total assets in FY12. This has occurred because of the company's recent acquisition of Cooper Industries, which has strongly uplifted the company's electric segment and the overall revenues have improved because of this acquisition despite the slow performance of the auto and trucks segments in Europe.

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Data Source: Morningstar

The above chart shows the DuPont breakdown of the company's return on equity over the last four years. The return on equity declined in FY12 due to a decrease in asset turnover. The vital point to be noted in this situation is that the return on equity is being obtained on the basis of net margins. The company is not depending upon disproportionately large levels of financial leverage in order to support its return on equity.

Comparative Analysis

In order to understand the position of the company in the industry and its extent of upside potential, a comparative analysis has been conducted using key valuation multiples.

Data Source: Morningstar

The above table shows the valuation indicators for Eaton Corp. as compared to ITT Corp. (NYSE:ITT), Johnson Controls Inc. (NYSE:JCI) and the overall industry. The table clearly shows that Eaton is undervalued across the earnings and book value multiples. At the same time, the company offers a higher dividend yield as compared to its competitors.

Conclusion

The strength of Eaton's business model coupled with its strategic acquisitions strategy is expected to further the company's growth. At the same time, the development of product portfolio shows that the company can adapt to changing trends, which makes it more desirable for long-term investors. The stock is also attractive for these investors on the basis of high-dividend yield and the undervaluation of the company also provides a substantial upside potential. Taking these factors into consideration, I recommend a buy stance on Eaton for the long-term investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Eaton Corp. Has Decent Long-Term Prospects