* All data are as of the close of Friday, November 14, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
The Electronics Wholesale industry is one of those that does not really have its own market driving forces, but rather depends on the forces acting upon other markets. Three other markets in particular - the technology, construction and materials sectors - will shape the electronics wholesale industry according to the demand forces acting upon them.
This, of course, is due to the industry's place in the scheme of things as a provider of electronics components, wiring and other supplies to companies in such fields as computers, automobiles, airlines, weapons systems, science labs, healthcare, and construction, among many others. As these industries are raised or felled by the unique market forces affecting them, the electronics wholesale industry is in turn indirectly affected by the conditions befalling the industries they service, as depicted in the graphs below.
During the market downfall from June 2007 until hitting bottom in early March of 2009, where the broader market S&P 500 index [black] fell 55%, the SPDR Technology Sector ETF (NYSE: XLK) [blue] fell 48%, and the SPDR Industrials Sector ETF (NYSE: XLI) [yellow] fell 61%, the three largest U.S. Electronics Wholesale companies - Avnet, Inc. (NYSE: AVT) [beige], Arrow Electronics, Inc. (NYSE: ARW) [purple], and Watsco Inc. (NYSE: WSO) [orange] - all fell comparable amounts of 63%, 64% and 51% respectively.
Naturally, the same would occur in reverse, with rising demand in its clients' industries helping to lift the Electronics Wholesale industry itself, as graphed below.
During the relentless recovery since the spring of 2009, where the S&P index has gained 200%, the technology fund XLK has gained 215%, and the industrials fund XLI has gained 267%, our three contestants have fared equally well - with Avnet jolting 175%, Watsco boosting 227%, and Arrow surging 275%.
Understanding the dependence that the Electronic Wholesale industry has on all these other industries, therefore, should help investors better anticipate the potential its companies offer. With the bull markets in consumer electronics, technology and construction all expected to continue for a few years more as interest rates are raised slowly and gradually, the Electronic Wholesale industry's upward run should thus continue itself, as tabled below where green indicates outperformance while yellow denotes underperformance.
Over the immediate term spanning this quarter and the next, the Electronics Wholesale industry is expected to deliver earnings growth that outperforms the broader market's average growth at some 1.24 to 1.68 times the rate.
Over the longer term, this tremendous impetus is seen accelerating at an even more robust 1.99 to 2.81 times the broader market's average growth in 2015 and beyond.
Zooming-in a little closer, the three largest U.S. companies in the industry are seen split performing - with Avnet and Arrow underperforming the broader market's average growth rate over the near term and in 2015, before outperforming modestly over the longer term, while Watsco simply surges ahead in outperformance mode all the way through.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Arrow posted the greatest revenue and earnings growth year-over-year by a substantial degree, while Avnet and Watsco split the slowest growth spots between them.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Watsco operated with the widest profit and operating margins, while Avnet contended with the narrowest.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, where Watsco's management team delivered the greatest returns on assets and equity, both Avnet's and Arrow's teams split the worst performance spots between them.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Avnet provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price with Arrow not far behind, while Watsco's DEPS over current stock price is the lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Avnet's stock is cheapest relative to forward earnings, company book value, and 5-year PEG, while Watsco's stock is the most overvalued in all three regards.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Arrow offers the highest percentage of current quarter earnings over current stock price, while Avnet offers the highest percentage the rest of the way. Meanwhile, Watsco offers the lowest percentages of earnings over current stock price for all time periods.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Watsco's stock is expected to post the greatest earnings growth rate overall, while Avnet delivers the slowest growth over the near term, and Arrow delivers it over the longer term.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Watsco's stock has the least upside potential and greatest downside risk, while Avnet's stock has the greatest upside and Arrow's has the least downside.
It must be noted, however, that Arrow's stock is already trading below its low target. While this may mean an increased potential for a sharp move upward, it may warrant a reassessment of future expectations.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up is analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Avnet is best recommended with 3 strong buys and 3 buys representing a combined 54.54% of its 11 analysts, followed by Arrow with 3 strong buy and 2 buy recommendations representing 45.45% of its 11 analysts, and lastly by Watsco with 2 strong buy and 2 buy ratings representing 28.58% of its 14 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is…Avnet by a mild electric jolt, outperforming in 12 metrics and underperforming in 8 for a net score of +4, followed close behind by Arrow, outperforming in 8 metrics and underperforming in 6 for a net score of +2, and finally by a short-circuited Watsco, outperforming in 12 metric and underperforming in 17 for a net score of -5.
Where the Electronics Wholesale industry is expected to outperform the S&P broader market significantly this and next quarters, substantially in 2015, and significantly beyond, the three largest U.S. companies in the space are expected to put in a split performance, with Avnet and Arrow underperforming near term before outperforming longer term, while Watsco outgrows its earnings over the broader market's across the calendar.
Yet after taking all company fundamentals into account, Avnet Inc. stands first among its peers given its lowest stock price ratios, highest cash over market cap, highest revenue over market cap, highest future earnings percentages over current stock price, best high price target, and most strong buy and buy analyst recommendations - narrowly winning the Electronics Wholesale industry competition.