Top 10 Values in the Industrial Sector

Study after study has shown that stocks with low price-to-earnings multiples significantly outperform high P/E stocks. Research from my favorite investing guru, New York University professor Aswath Damodaran, pegged the outperformance at anywhere from 9% to 12% per year, depending on the study period. That's big money we're talking about.

But you already know that you can't just go out and buy the stocks with the lowest multiples. Companies can trade at dirt cheap prices for a number of dire reasons, including low growth prospects, skepticism about earnings, or high risk of bankruptcy.

These dangerous stocks can quickly crater. Buy too many of them, and you'll increase your own risk of bankruptcy!

Thus, for a firm to be truly undervalued, Damodaran says in his book Investment Fables: "You need to get a mismatch: a low price-to-earnings ratio without the stigma of high risk or poor growth."

Of course, you're unlikely to find any high-growth, low-P/E companies out there. But Damodaran suggests setting a reasonable minimum threshold for earnings growth, such as 5%. There are also various ways to minimize risk, including staying away from volatile stocks or companies with dangerous balance sheets.

The screen's the thing
We're looking for companies with low price-to-earnings multiples, but also a relatively low amount of risk, and the potential for reasonable growth. Our screen today will cover the best value plays in the Industrials sector, as defined by my Capital IQ screening software.

There are 338 such companies with market caps topping $500 million on major U.S. exchanges. They have an average forward P/E of 19.3. Here are my parameters:

  1. In order to stay away from bankruptcy risk, I used Damodaran's suggestion and only considered companies with total debt less than 60% of capital.
  2. In hopes of capturing a reasonable amount of growth, I looked at Capital IQ's long-term estimates and kept only companies expected to grow EPS at 5% annually or better over the next five years. Furthermore, I required at least 5% annualized growth over the past five years.

Of the 115 companies passing the screen, here are the 10 with the lowest forward price-to-earnings multiples:

Company

Market Cap
(in millions)

Forward P/E

Debt-to-Capital

Estimated EPS
Growth

Add to Your Watchlist

Harbin Electric (Nasdaq: HRBN  )

$612

7.3

16%

20%

Add

 

Alliant Techsystems

$2,361

8.7

60%

8%

Add

 

Nacco Industries

$861

9.1

48%

52%

Add

 

L-3 Communications (NYSE: LLL  )

$8,756

9.3

37%

8%

Add

 

Northrop Grumman (NYSE: NOC  )

$18,784

9.6

24%

8%

Add

 

Raytheon (NYSE: RTN  )

$17,449

9.6

26%

9%

Add

 

General Dynamics (NYSE: GD  )

$27,376

10.2

19%

10%

Add

 

Lockheed Martin (NYSE: LMT  )

$27,346

10.3

57%

10%

Add

 

Oshkosh (NYSE: OSK  )

$2,822

10.5

43%

6%

Add

 

Elbit Systems

$2,371

11.1

38%

16%

Add

 

Source: Capital IQ, a division of Standard & Poor's.

There are lots of good research candidates here. To further stack the odds on your side, Damodaran says you can eliminate any companies that have restated earnings, or had more than two large restructuring charges over the past five years. And if volatile swings in price cause you to lose sleep, consider only companies with betas less than one.

If you're interested in keeping up with any of these companies, add them to your free watchlist by clicking the appropriate "add" button in the table. You can keep up with my other screening adventures by checking my archive and following me on Twitter.

Fool analyst Rex Moore is plum tuckered out. He owns no companies mentioned here. The Fool owns shares of General Dynamics, L-3 Communications Holdings, Lockheed Martin, Northrop Grumman, Oshkosh, and Raytheon. Alpha Newsletter Account, LLC owns shares of L-3 Communications Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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