* All data are as of mid-day Friday, December 5, 2014. Emphasis is on company fundamentals and financial data rather than commentary.
There are two times to buy tools stocks: after a war, and after a recession. Of course, there is always the holiday gift giving season, but that's just a quarterly boost. I'm talking about cyclical boosts, like the one the Small Tools & Accessories industry has been enjoying since the start of the economic recovery almost 6 years ago.
Although recessions may not experience the actual destruction of buildings and homes as wars will cause, they do draw funds away from maintenance, expansions and new construction projects, postponing them forward until better times arrive.
As noted in the graphs below, from 2006 to 2009 new building permits declined dramatically from their highest level since the early 1970s of 2.25 million annually down to their lowest level since at least the 1950s of 500 thousand annually. The decline in construction spending (orange box) was the worst concentration of shrinking spending since the second world war.
But once better times eventually come, look-out! In post-recession recovery just as in post-war reconstruction, there is plenty of work to be done. From 2010 onward, building permits have more than doubled to some 1.1 million annually during one of the most intense concentrations of increased construction spending (green box) since, again, the second world war.
Along with that increased construction, of course, comes the increased need for tools and accessories, and the windfall to companies who supply them, as graphed below.
Since the economic recovery began in early 2009, where the broader market S&P 500 index [black] has gained 205% and the SPDR Industrials Sector ETF (NYSE: XLI) [blue] which the tools industry belongs to has gained 275%, the nation's three largest Small Tools & Accessories companies - tools specialist Snap-on Incorporated (NYSE: SNA) [beige], welding and cutting specialist Lincoln Electric Holdings Inc. (NASDAQ: LECO) [purple], and turf and landscaping equipment specialist Toro Co. (NYSE: TTC) [orange] - have all hammered up the charts some 565%, 450% and 525% respectively.
On an annualized basis, where the S&P has averaged 36.18% and XLI has averaged 48.53%, Lincoln has averaged 79.41%, Toro has averaged 92.65%, and Snap-on has averaged 99.71% per year!
Looking forward, the Small Tools & Accessories industry looks set to build-up some pretty sizable earnings, as tabled below where green indicates outperformance while yellow denotes underperformance.
Over the immediate term, the industry's earnings are expected to outgrow the broader market's average growth rate at some 4.13 to 6.57 times, before flattening to a more sustainable 1.12 times growth rate in 2015, on its way back up to 1.39 times annually over the next five years.
Zooming-in a little closer, the three largest U.S. companies in the space are expected to split perform, as tabled below.
Over the immediate term, where Snap-on and Toro are expected to slightly under-grow the broader market, Lincoln's earnings are seen shrinking some.
But come 2015, all three are set to resume their robust growth, with Snap-on moving from the lower side to the higher side of the market, Lincoln outperforming slightly, and Toro keeping true to its name by outgrowing all with bullishness.
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, Toro posted the greatest revenue and earnings growth year-over-year, while Lincoln reported the slowest, even earnings shrinkage.
• 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, Snap-on operated with the widest profit and operating margins, while Toro 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, Toro's management team delivered the greatest returns on assets and equity, where Snap-on's and Lincoln's teams split the least returns 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, Snap-on provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Lincoln's DEPS over current stock price is 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, Toro's stock is cheapest relative to forward earnings and 5-year PEG, while Snap-on's is cheapest relative to company book. At the overpriced end of the spectrum, each company's stock is the most overvalued relative to a different ratio.
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, Snap-on offers the highest percentage of earnings over current stock price for the current quarter, where Toro offers them for the remaining time periods. At the low end of the scale, each company offers the lowest percentage for differing 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, where Snap-on offers the greatest earnings growth next quarter, Toro offers it this quarter, in 2015 and beyond. At the slow growth end of the spectrum, Lincoln is seen growing the slowest overall, with shrinkage in the current quarter.
• 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 Snap-on's stock offers the least upside potential and greatest downside risk, while Lincoln's stock offers the greatest upside and Toro's offers the greatest downside.
It must be noted, however, that Toro'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 are 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, Snap-on is best recommended with 1 strong buy and 2 buys representing a combined 60% of its 5 analysts, followed by Lincoln with 4 strong buy and 2 buy ratings representing 54.54% of its 11 analysts, and lastly by Toro with 0 strong buy and 1 buy recommendation representing 20% of its 5 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… Toro charging far ahead of its peers, outperforming in 16 metrics and underperforming in 9 for a net score of +7, followed far behind by Snap-on, outperforming in 11 metrics and underperforming in 12 for a net score of -1, with Lincoln trailing a distant third, outperforming in 5 metrics and underperforming in 11 for a net score of -6.
Where the Small Tools & Accessories industry is expected to outperform the S&P broader market substantially this and next quarters, modestly in 2015, and meaningfully beyond, the three largest U.S. companies in the space are expected to split perform near term with Lincoln shrinking some while the other two slightly underperform the market. Yet longer term all are seen outgrowing the market, with Toro leading the way.
After taking all company fundamentals into account, Toro grooms the nicest financial landscape given its lowest stock price to forward earnings and 5-year PEG, highest cash and revenue over market cap, highest trailing revenue and earnings growth, highest returns on assets and equity, highest future earnings over current stock price overall, highest future earnings growth overall, and best mean and low price targets - constructively winning the Small Tools & Accessories industry competition.