Narrowing Down Investment Opportunities in the Capital Goods Sector

Includes: CAT, CMI, DE, FLR, ITT, MMM
by: Erik Dellith

I recently searched across different sectors for companies where analysts have been upping their earnings estimates. The Capital Goods sector ranked among the best in this regard. Here, I discuss a screen to narrow down a search for companies in this sector.

The stock markets have been slammed recently, as the key indices have trended lower for more than a month. Given the many signs that the pace of economic growth is slowing in the US, I write a screen to focus exclusively on performance forecasts for this year and next. I want to highlight companies that analysts believe will continue to flourish even if macro growth eases a bit.

I recently went through a dozen sectors, looking first for companies where the current average earnings estimate is higher than it was four weeks ago. Then, I went through each sector looking for companies where analysts have lowered their earnings estimates. I use the ratio of the number of companies with upward revisions relative to the number of companies with downward revisions to consider sector exposure. With a ratio of 3.4 companies with upward revisions to downward revisions, the Capital Goods sector ranked favorably. (More precisely, current earnings estimates are higher than the EPS estimate four weeks ago at 17 capital goods companies. They are lower at five.)

Seventeen is still a relatively large number of stocks to consider. Think about the amount of time it would take to research each one. With that in mind, we want to narrow down our list a little bit more, preferably to less than ten names. To accomplish this, we turn to next year’s earnings estimates and focus on companies where analysts have been increasing their forecasts there, as well. This reduces our list to 16 names.

Given the weakness in the equity markets, we want to exclude some high-priced names. Part of the reason for this is defensive: figure, a “cheap” stock has less room to fall than an over-valued stock. Part of this is because we want to pick stocks that are good buys.

Using the average earnings estimates for this year and next, we filter for companies with forward P/E ratios that are less than the industry medians.

Lastly, we look at the PEG ratio – the forward P/E divided by the expected earnings growth rate. Lower PEG ratios indicate better value plays, but there is no magic number here. I choose the number of 1.5 for this screen, though investors preferring deeper value plays can set this number lower, perhaps 1.0.

On Friday evening, this screen resulted in a list of six companies, a number we can easily handle for further research to determine if any would be a good addition to a portfolio. Here is the list:

  • Caterpillar Inc. (NYSE:CAT)
  • Cummins Inc. (NYSE:CMI)
  • Deere & Co. (NYSE:DE)
  • Fluor Corp. (NYSE:FLR)
  • ITT Corp. (NYSE:ITT)
  • 3M Company (NYSE:MMM)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.