The Best Sector to Own Isn’t One You’d Think

Think you’ve got a bead on the best sectors to own? It’s amazing how often assumptions can differ from reality. While most investors may believe the technology or financial sectors tend to offer the biggest returns or the most earnings surprises, that’s not how it is. During the past five quarters, the most successful sector has been…

…The industrial sector.

Seriously. That’s not to say the group posted the biggest earnings increases in each and every single quarter since the start of 2011. But, in each of those quarters, the industrial sector was always among the top three sectors in terms of earnings growth. It was also almost always one of the top performers in terms of beating earnings estimates. During this time, no other sector has come close to the industrial sector’s consistently-reliable success.

True, the raw numbers tend to raise eyebrows, but what should really raise questions is the fact that we keep seeing so many earnings surprises from the sector, yet analysts continue to underestimate this clearly growing group. But you don’t have to dwell on this oddity too long. Rather, just take advantage of the boat so many other traders are missing, and get a little extra exposure to the sector.

And with that in your back pocket, here are three industrial companies that quietly make for great long-term holdings.

1. Textron (NYSE: TXT)

Though Textron is a fairly diversified industrial name, the bulk of its business is centered on aviation.

More important, after topping earnings estimates in each of the past five quarters — and in 13 of the past 14 — it’s tough to say Textron isn’t reliable. The fact that per-share profits in 2011 had more than doubled 2009’s is just gravy. In addition, the company’s bottom line is expected to grow 58% in 2012 compared with last year. This is simply outstanding for any company, let alone one in the industrial sector.

As for forward-looking growth drivers, think “business class” and “personal’ aircraft. While the average consumer may be in a spending slump, high net-worth individuals who can afford a personal aircraft are starting to find good reasons to buy them again. Deliveries of Textron-owned Cessna Citation jets grew 29% in the second-quarter on a year-over-year basis. Meanwhile, Cessna has revamped one of its propeller-driven planes so it can now be marketed in Europe.

2. Northrop Grumman (NYSE: NOC)

Northrop Grumman has beat earnings estimates for 12 straight quarters, which is amazing. And this isn’t even the most amazing fact about this defense contractor. Northrop’s earnings per share barely stalled even when the recession took its biggest toll in 2009. That year’s earnings of $5.21 per share matched 2008’s, and by 2010, the company was back into its multi-year consecutive growth groove. This year and 2013 are apt to dole out more growth.

But aren’t defense contractors in real trouble because of budget cuts? The federal government has already cut nearly half a trillion dollars from the military’s budget for the next 10 years, with another half trillion on the chopping block.

This is a concern for defense contractors in general, but not a big one specifically for Northrop Grumman. The company’s areas of expertise are unmanned systems, cybersecurity, intelligence and logistics. These segments are well shielded from mounting budgetary concerns, according to the company.

3. Joy Global (NYSE: JOY)

From a beat/miss perspective, Joy Global doesn’t look all that impressive. During the past six quarters, the mining-equipment manufacturer has topped earnings estimates three times and fallen short three times.

But what if those estimates were ridiculously high?

That’s pretty much the case. The corporation grew its bottom line by 35% in 2011 compared with the previous year, and is on pace to grow its income by 23% this year. That’s about as much as any investor has a right to hope for from an established company. Yet, analysts have been expecting more a great deal of the time. Don’t let the misses distract you from raw growth. After all, potential suitors have certainly noticed.

It’s been rumored that Chinese dump-truck manufacturer Komatsu was interested in acquiring Joy Global in late 2011 when the stock’s price was low and earnings growth was strong . Though that deal never happened, an acquisition isn’t out of the question, especially considering Caterpillar (NYSE: CAT) may have gotten a merger and acquisition ball rolling within the industry with its acquisition of Bucyrus in July last year. Factor in China’s growth stimulus now starting to get traction and a buyer may start poking around again. Even if not, this is still a great company.

Risks to Consider: While the strong odds of earnings beats and income growth may imply this is merely a quarter-to-quarter strategy, investors should make a point of not thinking in those terms. This is a longer-term trend best utilized by making sure industrial stocks are held over a period of several quarters rather than aiming for a quick, and often unpredictable, post-earnings bullish response.

Action to Take –>
It’s not always easy to stand pat with a relatively boring company in a relatively boring industry. But after five quarters of surprising success (and a sixth one in the works), it’s time to put excitement aside and start playing the numbers that are being repeatedly logged by the industrials sector. Any of the stocks discussed above would be a solid addition to a portfolio, but the one to start with may be Joy Global. With a price-to-earnings ratio of only 7.4 and last year’s profit growth of 35%, one could make the case that the stock is undervalued by as much as 50%.