1 Overlooked Stock That Broke Records This Week

Donaldson (NYSE: DCI  ) , the filtration and replacement parts maker, reported earnings for the quarter ended July 31 on Monday, and results broke quarterly and annual records. But it wasn't all rosy -- there are a few trends investors will want to watch carefully in order to gauge Donaldson's future prospects.

The breakdown
A $5.3 billion company with operations in North America, Europe, and Asia, Donaldson relies on mining, agriculture, construction, aerospace, and defense industries, as well as industrial end-users for its sales. The company is at once diversified and cyclical; the second half of its fiscal year (which ends July 31) tends to be more lucrative than the first half.

Luckily for Donaldson investors, this trend continued, and the company set fourth-quarter records in sales, operating margin, net margin, and EPS, as well as record sales and earnings for FY 2012. Not bad!

Revenues were up 5% from a year ago, while EPS rose 12%, to $0.43 per share. EPS growth was aided by Donaldson's repurchase initiatives; it bought back $130 million worth of stock, or 2.9% of diluted outstanding shares, during the year. Operating margins came in at 15.1%. The company projected margins to be between 13.7% and 14.5% in its 10-K last year, so it was great to see these come in higher than expected.

While its record results were somewhat buoyed by lower-than-usual tax rates that aren't expected to continue into the future, Donaldson's numbers were also boosted by a focus on its operational efficiency. Operating margins are expected to set new records again next year, and the company projects it will turn in another record-breaking performance.

What to watch for
Just because Donaldson had a great year doesn't mean it's going to continue to outperform. Here are a few things to watch for to gauge the health of Donaldson's future.

Global conditions
Investors in Donaldson should keep an eye on the health of the global economy. Ailing economic conditions in Europe and decelerating growth in Asia, where the company has operations, both threaten Donaldson's future growth prospects. The company has seen a slight slowdown in Asia, and replacement filter sales were down 5% in that market for FY 2012.

Exchange rates
Another major dynamic to watch going forward is the strength of the U.S. dollar against the euro. The company has based its fiscal 2013 outlook on a $1.24 dollar to euro exchange rate. The lower this number is -- the stronger the U.S. dollar is compared to the euro -- the less the company's earnings abroad will be worth when they bring them back to the states. Currently, about $1.25 can buy one euro, but if the euro gets cheaper, the company will have to grow more quickly in Europe to offset these fluctuations. The company said it expects "headwinds" due to foreign currency fluctuations of 5% in the first quarter, and 3% for the two following quarters.

Some final metrics
At the end of the day, Donaldson generates great returns for investors by the traditional metrics of return on investment (ROI), return on equity (ROE), and return on assets (ROA). Its ROI is more than three times the industry average, above 21%. It's ROA, too, is nearly three times the industry average of 5%, clocking in at 14.8%, and its ROE exceeds 26%, which is hard to find.

Investors should also take note of Donaldson's dividend. It's nothing crazy -- the current yield is just 1% -- but it's been growing at a extraordinary rate recently, averaging annual growth of 10% over the past five years. Fellow Fool Dan Caplinger notes that the company is about as consistent as it gets with its dividend -- it's paid one for the past 26 years. So while the yield isn't particularly high, its payout appears sustainable and likely to continue growing, and it displays none of the precarious qualities found in questionable dividends.

Of course there are other stocks in the pollution control industry with dividends, and Pall (NYSE: PLL  ) is notable because it has also grown its dividend in recent years. Although, as Selena Maranjian noted, its financial growth has not been as promising as Donaldson's. Pall spends 26% of its earnings on paying the annual dividend, while Donaldson pays just 18%. Compare Donaldson to another one of its competitors, Calgon Carbon (NYSE: CCC  ) , which doesn't even pay a dividend and returns less than 10% on assets, investments, and equity, and Donaldson looks even better.

Donaldson's quarterly results were impressive, and the stock looks like a better investment than shares in other similar companies. Just be watchful of exchange rates and broader economic trends in Europe and Asia, and you should have the right toolkit to make a sound decision on Donaldson's potential.

Of course, if you are an income investor, there are plenty of companies that pay higher dividends than Donaldson, though Donaldson's dividend growth has been impressive. Motley Fool analysts have done the work for you, selecting the three Dow stocks dividend investors need. Get your copy today for free to find out which blue chips pay solid, sustainable dividends that should continue for the long term.

Fool contributor John Divine owns none of the stocks mentioned in the story above, but he is one of the top filtration analysts in his cubicle. You can follow him on Twitter @divinebizkid and on Motley Fool CAPS @TMFDivine. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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