S&P recommends marketweighting the S&P 500 Industrials sector. Year to date through November 18, the S&P Industrials Index, which represented 10.6% of the S&P 500 Index, was down 6.3%, compared to a 3.3% decline for the S&P 500. In 2010, this sector index advanced 23.9%, versus a 12.8% increase for the 500. There are 18 sub-industry indices in this sector, with Aerospace & Defense being the largest at 24.9% of the sector’s market value.
S&P analysts have a positive fundamental outlook on the Industrials sector due to expected sales benefits from rising emerging market exposure, although Europe’s debt crisis has increased uncertainty, in our view. In addition, operating leverage is rising with revenues thanks to aggressive cost-cutting initiatives put in place by most companies during the extreme business downturn of 2008 and 2009. According to Capital IQ, from a valuation standpoint, the sector trades at 11.8X consensus estimated 2012 EPS, above the market’s 11.3X, due to above-average EPS visibility, in our view. Its P/E to projected five-year EPS growth rate of 0.9X is lower than the broader market’s 1.1X. The sector’s marketweighted S&P STARS average of 3.7 (out of 5.0) is slightly below the 3.8 average for the S&P 500.
The S&P Industrials Index have broken out from a fairly large, bullish base, turning the intermediate-term trend to bullish, in our view. In addition, prices have retaken a bearish trend-line off the highs since July, confirming to us the change in trend. The sector has also jumped back above its 17-week exponential moving average for the first time since July. The next area of overhead supply sits up near the 300 level, which was the major breakdown region. The rising 17-week exponential remains below the 43-week exponential, but the gap between the two is narrowing, a potentially bullish sign. Relative strength versus the S&P 500 has reversed to the upside, another positive sign. We have raised our technical opinion on Industrials to neutral with a bullish bias, from neutral.
We recommend marketweighting this cyclical sector due to increased risks we see to the global economic recovery, which we believe are offset by an improving technical outlook.
As the world’s largest defense contractor, Lockheed Martin (LMT) has amassed an enviable product portfolio. Lockheed turns 8% of revenue into operating cash flow, which it uses to fund dividends and stock repurchases. Still, budgetary pressures that require the Department of Defense (DoD) to reduce spending by $350 billion over 10 years could be expanded to more than $950 billion should Congress be unable to come to a consensus on the upcoming debt reduction discussions. However, LMT is on the technology side of DOD so they have not been hurt by budget cuts. Aeronautics houses key fighter aircraft programs such as the fourth generation F-16 and the fifth generation F-22 and F-35. The difference between fourth and fifth generation aircraft is related to stealth, computer systems, and the ability to process and integrate data to rapidly make informed decisions. LMT has a dividend yield of 4.9%.
We believe that Eaton’s expansion into developing markets will pay nice dividends, even while developed economies in the U.S. and Europe face challenges. Over the long run, we think the firm’s advanced technologies and high switching costs should lead to solid economic profit generation. Eaton is a diversified manufacturer of electrical components and systems across a broad number of end markets, but is importantly focused on the common theme of providing power solutions. Thus the firm has been successful at expanding its business well beyond its central focus of supplying to car and truck manufacturers, but hasn’t drifted too far outside of its core competencies. Eaton also has a long history of dividend growth, based on a target of growing EPS by 15% per year and dividends in a like amount. The dividend was maintained throughout the recession, and may grow once again as earnings recover.
The list of industrial stocks with bullish equity summary scores are shown in the table below: best dividend stocks of 2012 for industrials.