Investment themes\u2014social and economic trends that provide \u201ctail winds\u201d for certain companies\u2014can last for years and years.\u00a0 Washington is abuzz about \u201cincome inequality,\u201d which I highlighted as an investment theme in the late 1980s, advising clients to avoid the \u201cmediocre middle\u201d of retailing in favor of chains serving lower income folks or the affluent.\u00a0 You need to get two things right: correctly identify the theme and find good companies that really will benefit from it.\u00a0 Themes, including the ones discussed here, are often rather obvious, but they tend to get overlooked by professional investors focused on:<\/p>\n
Theme # 1: Purity Plays<\/b><\/p>\n
Thanks to globalization and rising living standards around the world, there is more and more concern \u2013 on the part of consumers, regulators, and companies \u2013 about a broad range of contaminants that must be avoided:<\/p>\n
It is \u201cmission critical\u201d for governments and companies to avoid these contaminants.\u00a0 Bird flu in China cratered YUM\u2019s stock price and caused a 20 percentage point swing in earnings.\u00a0 Therefore, respected and reliable companies that can help customers detect and eliminate contaminants enjoy strong demand and have ample pricing power; they include Ecolab, Clorox, and instrument makers such as Thermo Fisher and Agilent.<\/p>\n
Theme # 2:\u00a0 A Cleaner, Greener, Safer Infrastructure<\/b><\/p>\n
Much of the global energy and industrial infrastructure is being rebuilt to increase energy efficiency; reduce emissions of particulates, toxic substances, and CO2; and make the built environment (vehicles, houses, hospitals, airports) safer.\u00a0 This phenomenon has many interlocking elements, including:<\/p>\n
Ways to play this broad theme include: engineering and construction stocks such as Fluor; diversified industrial stocks such as GE, Siemens, and 3M; semiconductor and electronics stocks with exposure to the automotive and industrial markets; vehicles with lower emissions such as Cummins Engine, Honeywell, and Borg Warner; makers of thermostats such as Honeywell (which will have to compete with Google following GOOG\u2019s acquisition of Nest).<\/p>\n
Theme #3:\u00a0 Emerging Market Demand<\/b><\/p>\n
Emerging markets may be slowing but they are still growing, \u00a0and as they develop they need a lot of what sophisticated companies in developed nations produce, in such areas as:<\/p>\n
Many diversified industrials sell into these markets, including GE, UTX, MMM, ETN, PH, ITW, DHR, EMR and many others.\u00a0 Short Wall Street research reports fail to convey how the three themes discussed above drive earnings.\u00a0 In the slide deck accompanying its latest earnings report, 3M gave us a\u00a0 flavor by highlighting three items:<\/p>\n
Three Themes Propel Superior EPS Growth by Industrial Companies<\/b><\/p>\n
Obviously these three themes overlap and intersect, but they are all positive for companies involved in creating a cleaner, safer environment in emerging and developed economies.\u00a0 That is bullish for a broad range of industrial companies and their suppliers, including many tech firms.\u00a0 But perhaps this thematic talk sounds too ethereal and abstract.\u00a0 To measure its real world financial impact, I created two groups of stocks and compared their earnings growth, dividend yields, and valuations:<\/p>\n
The industrial stocks grew much faster than the staples stocks, had somewhat lower dividend yields, and about the same PE ratio.<\/b>\u00a0 Specifically:<\/p>\n Bottom line: the industrial stocks look more attractive<\/b>.\u00a0 Using the metric [PE \/ (EPS growth rate + dividend yield)], the industrials get a valuation score of 1.41 or [18.2\/(10.8 + 2.1)], which is much cheaper than 1.76x for the staples stocks<\/b> [18.0 \/ (7.3 + 2.9)].<\/p>\n Of course, these scores use historical growth rates and only have investment significance today if these growth rates continue<\/b>.\u00a0 That\u2019s where thematic analysis comes in.\u00a0 I think the three themes identified here will, in fact, continue to drive faster earnings growth for the industrial stocks than the staples stocks– particularly because such firms as PEP, KO, CPB and MCD will be hurt by a global push for healthier foods to fight obesity and diabetes.<\/p>\n Copyright Thomas Doerflinger 2014.\u00a0 All Rights Reserved.<\/p>\n Full disclosure: I own quite a few of the stocks mentioned in this post but I am not specifying which ones to avoid appearance of an endorsement.<\/p>\n","protected":false},"excerpt":{"rendered":" Investment themes\u2014social and economic trends that provide \u201ctail winds\u201d for certain companies\u2014can last for years and years.\u00a0 Washington is abuzz about \u201cincome inequality,\u201d which I highlighted as an investment theme in the late 1980s, advising clients to avoid the \u201cmediocre … Continue reading \n