The following is an analysis of the Diversified Company Industry. The analysis will use a system that I designed that is based on the ratio that Mr. Warren Buffett released to the public in 1986, which he coined "Owner Earnings." For those new to this type of analysis, I would recommend reading an introduction to my system by clicking here. My goal is ultimately to analyze all non-financial industries and then to subsequently re-analyze them every quarter. My purpose in writing these articles is to show the power of Mr. Buffett's ratio in analyzing industries, stocks, ETF's, Mutual Funds and individual portfolios. If one can fill their portfolios with companies that score high using my system and avoid those which fail, one should be able to increase the probability of becoming a successful investor in my opinion.
So let us begin by giving you the owner earnings numbers for the Diversified Company Industry:
The companies in the Diversified Company Industry operate in variety of fields and are comprised of businesses that manufacture a wide variety of products. Many of these companies also provide services to other businesses. The most widely known company in the table above is General Electric (GE). General Electric is one of the most diversified companies in the world operating in the following segments: Energy, Infrastructure, Aviation, Healthcare, Transportation and GE Capital. The reason that it only scores a "2" in the table above is because its total capital employed is $472 billion and even though its owner earnings are $16.72 billion, its GE Capital division is holding it back from scoring high on our FROIC test.
Being a market historian as well as an analyst, I thought everyone would enjoy seeing an owner earnings history of General Electric from 1973-2012:
When looking at the owner earnings history of General Electric, one can clearly see the benefit of having a superior manager as CEO and how that can benefit a company. When Mr. Jack Welch took over the company as CEO in 1981, he inherited a CapFlow of 83% and when he handed over the reins in 2001, he left with one of only 14%. He also grew owner earnings from $.04 in 1981 and left with one of $1.85. For those keeping track, that comes out to a 4,525% growth rate of owner earnings over 20 years or 21.13% annualized.
Since that time General Electric's management has struggled and has never again reached the $1.88 achieved in 2002. Another amazing thing is that only once in those 20 years at the helm did Mr. Welch not grow owner earnings. In 1980, the year before Welch became CEO, General Electric recorded revenues of roughly $26.8 billion; in 2000, the year before he left, they were nearly $130 billion. The company went from a market value of $14 billion to one of more than $410 billion at the time of his retirement, making it the most valuable and largest company in the world, up from America's tenth largest by market cap in 1981.
Getting back to our industry table above, this industry has a lot of wonderful companies in it, which are also well managed. The one's that came in with a scores of "three" are:
6:15 PM Industrial equipment maker Crane (CR) could see some weakness tomorrow after reporting Q4 revenue of $631.6M (+10% Y/Y) and EPS of $0.68, missing consensus by a solid $18.2M and $0.22. Crane is also guiding for 2012 revenue growth of 3%-5% (5.8% consensus) and EPS of $3.75-$3.95 ($3.86 consensus).
Before buying a company, I always wait for it to report before doing so. That way I am reactive instead of proactive and I don't suffer a large loss if it misses.
2) GenCorp (GY) = is a company I used to own but sold in order to go to cash after the congressional debt limit/S&P downgrade fiasco that happened in 2011. That event forced me to go to 90% cash. I have not repurchased the company, because it is also in the aerospace and defense business and that is an area that is the #1 target of President Obama's planned budget cuts. If the President loses in November, I will probably buy it back, because the kicker in this company is that it owns 12,600 acres of Sacramento, California real estate. When you figure that the company has a market capitalization of $325 million and if you divide that by 12,600 acres, you get $25,793 an acre. So in effect, you are basically getting the aerospace and defense business for free when buying GenCorp.
3) Honeywell International (HON) = is a defense company that will be hurt by the proposed defense cuts. Jack Welch tried to buy out Honeywell as one of his last mergers before he retired but was unsuccessful.
Seeking Alpha Market Currents
December 15, 2011 Honeywell drops 1.8% after establishing its 2012 financial outlook. The conglomerate expects 2012 EPS of $4.25-$4.50 and sales of $37.8B-$38.9B; the former is in-line with a consensus of $4.43, but the latter is largely below a consensus of $38.9B. Free cash flow is expected to be flat Y/Y at $3.5B. "We're planning for a more challenging macro environment in 2012," says CEO Dave Cote.
The challenging macro environment that Mr. Cote is referring to is probably Mr. Obama's proposed defense cuts.
4) National Presto (NPK) = is a company that possesses an amazing owner earnings history:
Unfortunately a nice chunk of its business comes from making bullet cartridge cases for the military and with the war over in Iraq and with the downsizing of the military as a whole, National Presto may have a few tough years ahead of it.
5) Parker Hannifin (PH) = Parker Hannifin is the world's leading diversified manufacturer of motion and control technologies and systems. 76% of their business comes from Industrial sources so if manufacturing ramps up in the near future, it will be one of the first to benefit. It unfortunately missed on their earnings by $.06 on January 20, 2012 and were punished for it:
6) Standex International (SXI) = for decades Standex has always been a good generator of owner earnings, but has never been able to break out. The current management has done an excellent job of restructuring the firm and they are expected to bring its long term debt down to zero this year. Its CapFlow is excellent and its FROIC steady, so I would definitely put this stock on your watch list as it is still a small capitalization stock, but that may not be for much longer, as management is on the right course.
7) 3M Company (MMM) = this old warhorse of the Dow Jones Index is unfortunately suffering from the global recession as it operates in 65 countries. It is reporting its earnings at the end of this week and it will be interesting to see what happens as the company is a bell weather of the global economy. Since it produce tens of thousands of products, which in most cases are either the #1 or #2 in their categories, it is definitely watched closely whenever it reports.
In investing we are taught to diversify and since most of the companies in the table above pay a nice dividend, you can enhance your diversification by buying many of these names when the time is right.
Disclaimer: Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. The information contained in this article represents the opinions of Peter "Mycroft" Psaras, and should not be construed as personalized investment advice. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.