* All data are as of the close of Friday, January 30, 2015. Emphasis is on company fundamentals and financial data rather than commentary.
The Industrial Electrical Equipment industry is another of those multi-purpose categories that houses a wide variety of companies. While companies in this space offer pretty much the same types of products and services - such as electrical systems that connect and regulate electric power, water, heating, and communications infrastructure - they often cater to specific markets, and are thus at the mercy of their principal sector.
For instance, each of the three largest U.S.-based companies in the industry has a slightly different focus in electric, water and communications components respectively, as follows:
• Emerson Electric Co. (NYSE: EMR), headquartered in St. Louis, Missouri, provides technology and engineering solutions for precision measurement, control, monitoring, asset optimization, safety and reliability of reservoirs and plants to the oil and gas, refining, chemicals, power generation, pharmaceuticals, food and beverages, pulp and paper, metals and mining, and municipal water works industries. Its products include motors, drives, power generating alternators, fluid controls, electrical distribution devices, and materials joining equipment, in addition to power transmission, climate control, heating and cooling, air conditioning, and refrigeration solutions.
• AO Smith Corp. (NYSE: AOS), headquartered in Milwaukee, Wisconsin, manufactures and sells water heaters and boilers to residential and commercial markets, which include electric, natural gas, liquid propane, solar tank, and tankless gas water heaters to residences, restaurants, hotels and motels, laundries, car washes, office buildings, small businesses, hospitals, schools, swimming pools and spas.
• Belden Inc. (NYSE: BDC), headquartered in St. Louis, Missouri, designs, manufactures, and markets signal transmission solutions used in the television broadcast, cable, satellite, and IPTV industries. Its products include camera mounted fiber solutions, interfaces and routers, broadcast and audio-visual cable solutions, monitoring systems, outside plant connectivity products, fiber and copper connectivity products, and other communications infrastructure equipment including ethernet equipment, routers and gateways, network management software, and wireless systems.
Thus, an investment in one of these companies is pretty much an investment in the particular sector they cater to, which is clearly noted in the following graphs of their stocks' performance.
During the last market meltdown as graphed below, where the broader market S&P 500 index [black] fell 56% and the SPDR Industrials Sector ETF (NYSE: XLI) [blue] fell 63%, both Emerson and Smith outperformed both benchmarks, falling only 50% each. At the time, the oil and gas industry was still relatively strong and helped keep Emerson powered up, while residences and commercial buildings still needed heat and water, helping keep Smith's finances warm and liquid.
Belden [orange], however, remained disconnected from the pack, falling 85% as the demand for technology and communications products waned.
The economic recovery since then has again affected each company differently, as graphed below. Where the S&P index has risen 195% and XLI has risen 260%, Emerson had managed to keep pace up until the middle of 2014, since which time it has dropped off significantly from gains of 180% down to gains of just 130%. The cause? Emerson's drop coincides with the fall in the oil price and the subsequent slowdown in the energy sector - impacting one of Emerson's largest markets.
Smith and Belden, however, have both flourished rather impressively, rising 750% and 900% respectively. The continuing recovering in the housing and commercial construction markets has increased Smith's water and heating segments, while the pick-up in the technology, healthcare, and consumer discretionary sectors have boosted Belden's communications infrastructure activities.
Your choice in companies should thus factor-in your outlook for each company's principal market, and not simply focus on the company's internals alone.
Looking at future earnings growth, the Industrial Electrical Equipment industry as a whole is expected to reel under the pressures suppressing industrial activity overall, as tabled below where green indicates outperformance while yellow denotes underperformance relative to the broader market.
Over the current quarter and the 2015 reporting year, the industry's earnings growth is expected to not only underperform the broader market's average earnings growth but is also seen shrinking rather dramatically.
Yet over the longer term, forecasters anticipate a strong rebound as economies slowly recover locally and abroad, with the Industrial Electrical Equipment industry's earnings expected to outgrow the S&P's average at some 1.60 times its growth rate annually over the next five years.
Zooming-in a little closer, the three largest companies in the space are expected to continue pretty much inline with their recent progress during the recovery, as tabled below.
Emerson is seen continuing its underperformance relative to its peers and the broader market. Smith is also expected to struggle near term, but is then seen outgrowing its peers and the broader market at some 2.74 times over the next five years. Belden, for its part, is expected to lead the way near term with very strong growth at some 2.21 to 2.48 times the S&P's average, before slipping to a very slight market-outperform over the next five years.
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, Belden delivered the greatest trailing revenue growth year-over-year, where Smith delivered the greatest trailing earnings growth. At the low end of the scale, Emerson delivered the least growth in both metrics, even 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, Smith operated with the widest profit margin, Emerson enjoyed the widest operating margin, while Belden contended with the narrowest in both.
• 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, Emerson's management team delivered the greatest returns on assets and equity, where Belden's team delivered the least.
• 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, Emerson provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Belden'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, Emerson's stock is the cheapest relative to forward earnings, where Smith's is cheapest relative to company book value and 5-year PEG. At the overpriced end of the spectrum, where Smith's stock is the most overvalued relative to earnings, Belden's is the most expensive relative to company book and PEG.
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, Belden offers the highest percentage of earnings over current stock price for the current quarter where Emerson offers it for the remaining periods, while Smith offers the lowest percentage for all 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, Belden offers the greatest growth over the near term, where Smith offers it over the next five years. At the low end of the scale, Emerson offers the slowest growth overall, where Smith offers it next quarter, even shrinkage.
• 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 Emerson's stock offers the greatest upside potential and least downside risk, where Belden's offers the least upside and Smith's offers the greatest downside.
It must be noted, however, that Emerson's stock is already trading below its low target. While this may mean 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, Belden is best recommended with 4 strong buys and 2 buys representing a combined 75% of its 8 analysts, followed by Smith with 4 strong buy and 3 buy ratings representing a combined 70% of its 10 analysts, and lastly by Emerson with 4 strong buy and 5 buy recommendations representing 33.33% of its 27 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… Emerson with an electrifying victory, outperforming in 14 metrics and underperforming in 10 for a net score of +4, with Smith and Belden left out in the cold and out of the loop with net scores of -2 each.
Where the Industrial Electrical Equipment industry is expected to underperform the S&P broader market substantially this and next quarters with earnings shrinkage, before out-growing the market moderately over the next five years, the three largest U.S. companies in the space are expected to follow closely the performance of their respective sectors - with Emerson still underperforming along with the energy sector, Belden outgrowing all near term on the strong demand for communications infrastructure, and Smith slumping near term as construction slows before picking up again longer term.
Yet after taking all company fundamentals into account, Emerson Electric Co promises to power-up portfolios the most, given its lowest stock price to forward earnings, widest operating margin, greatest returns on assets and equity, highest EBITDA over market cap and revenue, highest diluted earnings over current stock price, highest future earnings over current stock price overall, highest dividend yield, and best price targets - handily winning the Industrial Electrical Equipment industry competition.