This is part seven of a seven-part series that is looking at the incredible opportunity that a cyclical company can represent as earnings recover coming out of a recession. A primary objective of this series is to illustrate that price drops of well-established companies are usually temporary even after earnings are cyclically weak.
Part one, 6 High Profile Industrials With Staggering 3-Year Performance, provided a cursory view of six industrial companies. In the part prior to this one, we looked at Ingersoll-Rand (IR) in Rand: Profit by Investing in Recovering, Large, Well-Entrenched Cyclicals. You can find the entire series here.
Illinois Tool Works (NYSE:ITW) is a diversified industrial manufacturer with a history of growth through innovation, and through acquisitions. A quote from their introductory video sums up Illinois Tool Works' business units very nicely:
...if it's wrapped, scrapped, fastened or welded; built, connected, balanced, or sliced; decorated, packaged, labeled or protected; chances are Illinois tool Works is behind it.
Illinois Tool Works operates seven primary business segments and an additional miscellaneous segment. For the transportation industry, they manufacture components, fasteners, fluids and polymers. For industrial packaging they manufacture steel, plastic and paper products used for building, shipping and protecting goods in transport. The power systems and electronics unit manufactures power conversion and electronics. The food equipment segment builds commercial food equipment. And in construction products they build tools, fasteners and other construction products. The polymers and fluids unit manufactures adhesives, sealants, lubricants and other fluids. With their decorate services unit they manufacture items such as countertops and flooring.
Although Illinois Tool Works operates a widely diversified collection of businesses totaling more than 850 businesses in over 57 countries, they operate under a decentralized management approach. Furthermore, Illinois Tool Works has proven itself as one of the most successful practitioners of the 80/20 business model. Illinois Tool Works understands that 80% of their sales are derived from 20% of its products being sold to key customers. Therefore, the company has proven itself capable of focusing on its most profitable products and clients.
Illinois Tool Works Growth Strategies
Illinois Tool Works has a long history of generating above-average returns by creating innovative products for unexciting but necessary aspects of the needs of their customers. In short, Illinois Tool Works' products help customers solve some of their most complex problems. Illinois Tool Works is one of the leading recipients and holders of patents worldwide. In 1969 the company founded the Illinois Tool Works Patent Society of employees, with more than 800 members comprised of engineers, technicians and other innovative thinkers. A constant stream of new and innovative products has been a cornerstone of Illinois Tool Works' growth.
Acquisitions also represent a very important growth driver for this diversified manufacturer. In fiscal year 2010 alone the company made almost 25 acquisitions acquiring revenue of over one-half of a billion dollars. In the first quarter of fiscal 2011 they already closed an additional six acquisitions generating revenues in excess of $300 million. Illinois Tool Works' goal is to add revenue growth of approximately $1 billion in fiscal year 2011 through acquisitions. In addition to expanding their business into new markets, acquisitions also strengthen their standing in existing markets.
The following logarithmic F.A.S.T. Graphs™ plots earnings only for Illinois Tool Works since calendar year 1992. This graph provides a picture of an above-average growth company with only a modest level of occasional cyclicality, typically only occurring during recessions. However, due to the growth strategies discussed above, this well-managed company usually generates prolonged periods of above-average growth after recessions end.
The complete historical earnings and price correlated F.A.S.T. Graphs™ below provides an instantaneous depiction of this quality company in picture form. From the graph it becomes immediately obvious that Illinois Tool Works is a solid growth story with an above-average earnings growth rate of 9.4%. The company also offers a strong dividend yield of 2.8% and a solid capital structure with a debt equity ratio of only 21%.
But most importantly, the graph shows that Illinois Tool Works currently can be bought at a valuation that is low by historical standards. With the black monthly closing stock price line below the orange earnings justified valuation line, Illinois Tool Works appears to be on sale. The graph shows that it is very rare to find Illinois Tool Works' stock price sitting at or below the orange earnings line. Therefore, the current PE ratio of 13.9 represents an attractive entry point, if history is any guide.
The performance report associated with the above graph reflects the opportunity that Illinois Tool Works offers investors. First of all, a review of the dividend cash flow table illustrates a consistent record of dividend growth that was maintained through both the recession of 2001 and the great recession of 2008. Also, even when considering its current low valuation, this quality company was still able to generate market-beating returns since calendar year 1997. Therefore, we would offer that it would also be logical to assume that purchasing the company when the valuation is low, like it is today, could lead to enhanced future returns (see the estimated earnings and return calculator below).
The consensus of 20 analysts reporting to Capital IQ, expect Illinois Tool Works to grow earnings at an annual rate of 14.1% going forward. This rate would be typical of its historical pattern of above-average growth coming out of recession. Therefore, above-average returns and dividend growth would follow if these earnings growth expectations were achieved.
As we put the finishing touches on this final installment of this seven part series, the stock market is gripped with fear and falling. Consequently, valuations on many stocks are becoming more attractive than they've been for almost two years. This series of articles was focused on the notion that investing in common stocks when there is blood in the street represents the best time to buy. However, when investors are gripped with fear they become almost incapable of thinking clearly. But even worse, they tend to accentuate the negative and blow their worst fears completely out of proportion.
If you go back and look at the earnings and price correlated F.A.S.T. Graphs™ on each of the six companies covered in this series, you will see that each was overvalued based on earnings only a few months ago. But, when these stocks were overvalued, few investors were afraid of them. Since their prices were high, they were good stocks and most people wanted to own them. This is counterintuitive to how people would behave in any other market. In most markets when things go on sale, people want them the most. How peculiar, that we don't look at our quality companies with strong fundamentals in the same way.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.