Building a Model Income Portfolio Sector by Sector: Part 6 - Industrials

by: Clay King

In the sixth article in our series on building a model income portfolio by sector, we turn to industrials. Included in this sector are defense contractors, electrical manufactures, tools, parcel delivery, and waste companies. The S&P 500 sector weightings are shown in the table below.

S&P 500 Sector Weights

Consumer Discretionary 10.7%
Consumer Staples 10.7%
Energy 12.6%
Financial 15.0%
Heath Care 11.9%
Industrials 11.2%
Information Technology 17.7%
Materials 3.6%
Utilities 3.4%
Telecom Services 3.1%

Over the last twenty years, the industrial sector has averaged a return of 9.4%. The worst 12 months was -54% and the best period was +69%. The S&P 500 returned 8.1% with a worst best return of -44% to +50%.

Our screen for candidates to diversify our income portfolio in this sector consisted of the following criteria:

  • A yield in excess of 2.5%.
  • A payout ratio below 60%.
  • 5 consecutive dividend increases.
  • A dividend growth rate over the last five years in excess of 4%.

The following table lists the data for the companies surviving the screen:

Industrial Dividend Criteria
Company Current Yield Dividend Growth Rate Previous 5 Years Payout Ratio P/E Est. Current Year Est. Long Term Growth Rate
General Dynamics 2.8% 14% 25 9.4 7%
Lockheed Martin 4.0% 20% 40 9.9 10%
Northrup Grumman 3.4% 11% 30 8.7 8%
Raytheon 3.9% 5% 30 8.8 8%
Emerson Electric 2.8% 9% 46 15 15%
Stanley/Black & Decker 2.5% 5% 34 12.4 3%
ABM Industrials 2.5% 5% 41 15.4 10%
Waste Management 4.4% 9% 60 14.6 10%

The defense companies might come under fire from possible budget cuts from Washington. The stocks have pulled back the last several days on these fears. Waste Management (NYSE:WM) has retraced about 50% of its bull market advance on recent earnings that fell short of wall street expectations. Though the shares may be dead money for the next 1-2 quarters, the yield level is becoming quite attractive. Emerson Electric (NYSE:EMR) is a solid long term investment, however, it is not necessarily a great value at present levels. One of the benefits of the industrial sector is the long list of good candidates that reside within it.

For example, the following stocks, though not clearing this screen, are also excellent securities to add to one's watch list:

  • Republic Services (NYSE:RSG)
  • Illinois Tool Works (NYSE:ITW)
  • Eaton (NYSE:ETN)
  • 3M Company (NYSE:MMM)
  • United Parcel (NYSE:UPS)
  • Honeywell (NYSE:HON)
  • Mine Safety Appliances (NYSE:MSA)
  • General Electric (NYSE:GE)

The yield levels over the past 25-30 are shown in the following table.

Industrial Historical Yield Ranges

Company Current Yield Monthly High Monthly Low Median
General Dynamics 2.8% 4.3% 1.1% 1.7%
Lockheed Martin 4.0% 5.1% 0.6% 1.6%
Northrup Grumman 3.4% 9.2% 1.3% 2.8%
Raytheon 3.9% 4.5% 1.1% 2.5%
Emerson Electric 2.8% 4.7% 1.7% 2.6%
Stanley/Black & Decker 2.5% 5.6% 1.4% 2.9%
ABM Industrials 2.5% 5.3% 1.2% 2.5%
Waste Management 4.3% 4.3% .03% 2.3%

From a combination of past history, earning and dividend trends, and analyst expectations of future growth, coupled with valuation levels, I find several of these most attractive at current levels:

  • Waste Management (WM): Current yield at high level at 4.4% and P/E at levels in lower third of the historical range.
  • Lockheed Martin (NYSE:LMT): Low P/E, yield at higher end of historical range.
  • Raytheon (NYSE:RTN): Both P/E and yield at excellent valuation levels.
  • General Dynamics (NYSE:GD): Low P/E and yield in upper 1/3 of historical yield levels.

From a personal perspective, though General Electric (GE) did not make the screen because of a dividend cut in 2009, I like the shares for accumulation. Many investors find themselves unable to buy stocks with a recent dividend cut, however, I find the 100 year plus history of GE more compelling.

Disclosure: I am long LMT, WM, GE.