These Dow Stocks Are Flashing Red

So far in this series of commentaries on the Dow Jones Industrial Average component stocks that are in each S&P 500 sector, we have looked at the telecommunications, financial, consumer discretionary, consumer staples, healthcare, and energy sectors. I reviewed each sector in the order of their returns year to date. Due to a few down market days, we continue to see shifting occur. The following chart ranks each Dow sector by total return year to date, including dividend yields. Our next sector under review, industrials, has passed energy with a slightly higher return, and is comprised of 3M Company (NYSE: MMM  ) , Boeing (NYSE: BA  ) , Caterpillar (NYSE: CAT  ) , General Electric (NYSE: GE  ) , and United Technologies (NYSE: UTX  ) . Let's see how they have done so far this year.

Dow Sector

Total Return YTD

Financials

31.33%

Consumer Discretionary

24.18%

Telecommunications

17.55%

Health Care

15.75%

Consumer Staples

12.90%

Industrials

5.17%

Energy

4.91%

Materials

(1.91%)

Information Technology

(9.08%)

Source: Yahoo! Finance

Company

Year To Date G/L

Dividend Yield

Total Return YTD

Price/Earnings Ratio LTM

Earnings Quality Score

3M

5.86%

2.67%

8.53%

14.46

C

Boeing

(2.21%)

2.42%

0.21%

12.54

B

Caterpillar

(11.97%)

2.51%

(9.46%)

8.48

C

General Electric

15.83%

3.20%

19.03%

16.88

C

United Technologies

4.58%

2.74%

7.32%

16.37

C

Total Average

2.42%

2.71%

5.13%

13.75

C+

Source: S&P Capital IQ

In the past, my research has incorporated a Motley Fool Earnings Quality Score that taps into a database that ranks individual stocks. The database designates an A through F weekly ranking, based on price, cash flow, revenue, and relative strength, among other things. Stocks with poor earnings quality tend to underperform, so we look for trends that might predict future outcomes.

3M
3M recently reported and missed consensus earnings estimates, but $1.65 per share was still 9% better than last year's number. The company lowered its profit expectations for 2012 citing "current economic realities." According to CEO Inge Thulin, 3M sees a "slow-growth economy" and challenging market conditions through the end of the year.

3M's revenue growth has been anemic the last four quarters, and was down from same quarter last year to $7.497 billion. Gross, operating, and net profit margins all improved by 1% each year over year to 48%, 22%, and 15%, respectively.

Metric

09/30/2012

09/30/2011

% +/-

Revenue (billions)

$7.497

$7.531

(0.45%)

Days Sales Outstanding

54

52

3.7%

Accounts Receivable (billions)

$4.409

$4.259

3.4%

A/R as % of Revenue

59%

57%

2.0%

Days Sales in Inventory

89

82

7.9%

Inventory (billions)

$3.842

$3.604

6.2%

Inventory as % of Revenue

51%

48%

3.0%

Operating Cash Flow (billions)

$1.345

$1.362

(1.26%)

Source: S&P Capital IQ

3M's earnings quality has been hurt primarily by receivables and inventory metrics rising in the face of a slightly declining revenue trend. 3M's consistent share repurchases over the last two years likely boosted earnings. The company could rebound when things improve.

Boeing
Despite rising costs that have pressured margins, Boeing reported increased quarterly revenue year over year of $20 billion, a 12.87% increase. The company also raised its 2012 earnings guidance to $4.80-$4.95 a share -- its third increase this year. However, rising pension costs along with possible defense sequestration cuts will likely force a reset of 2013 earnings estimates. Per-share earnings were down 8% for the quarter year over year, to $1.35.

Earnings quality metrics are almost the reverse of 3M's:

Metric

09/30/2012

09/30/2011

% +/-

Revenue (billions)

$20.008

$17.727

12.87%

Days Sales Outstanding

25

32

(28.0%)

Accounts Receivable (billions)

$5.437

$6.296

(15.8%)

A/R as % of Revenue

27%

36%

(25.0%)

Days Sales in Inventory

200

194

3.0%

Inventory (billions)

$36.817

$30.493

17.18%

Inventory as % of Revenue

184%

172%

6.54%

Operating Cash Flow (billions)

$1.596

$0.449

71.87%

Source: S&P Capital IQ

Boeing would be ranked "A" for earnings quality if it weren't for its rising inventory and days sales in inventory. Boeing enjoys a rising backlog of $15.619 billion because airlines are looking to modernize to more fuel efficient fleets. If left unresolved, the sequestration issue will hurt Boeing going forward.

Caterpillar
For the third quarter ended Sep. 30, Caterpillar missed estimates on revenues, met earnings per share expectations, revised down its 2012 guidance, and said it doesn't expect much 2013 revenue improvement. CAT showed surprising operating and net profit margin improvements year over year, from 11% to 16%, and from 7% to 10%, respectively.

CAT's receivables grew $500 million year over year to $9.814 billion, and days sales in inventory jumped from 115 to 138 days. Inventory as a percentage of revenue also increased from 92% to 107%, while operating cash flow dropped 43.5% to $1.255 billion. CAT carries $26.526 billion in debt. Revenue growth at only 4.43% indicates a slowdown from prior quarters. CAT competes on a global basis and Europe and Asia are sickly at present. As of June 30, CAT's backlog was $28.2 billion.

GE
GE's CEO Jeffrey Immelt recently noted on CNBC's Squawk Box that the company's organic growth last quarter was around 8% -- "very good" for a company of GE's size. He also noted GE is "very long" in natural gas plays, green energy, and in other long cycle businesses.

GE's stock performance this year is largely due to its financial segment's improving health. But five years ago GE traded at $40 a share. Notably GE's cost of goods sold jumped 65.3% to $27.466 billion, and days sales in inventory dropped from 82 to 53 days year over year. GE's tax rate of 15% (earnings before taxes) is among the lowest of any Dow component. GE continues to transfer some operations overseas where operating costs are lower than in the U.S.

United Technologies
United Technologies is aggressively repositioning itself for future military procurements while preparing for a worst-case scenario of possible sequestration. It recently acquired Goodrich, a defense company, while selling Hamilton Sundstrand. UTX recently reported better than expected earnings on a tepid revenue increase of only 1.6% to %15.042 billion. Still, $1.37 a share was 7% lower than last year same quarter. The company announced possible job cuts due to possible lower demand for military equipment.

Metric

09/30/2012

09/30/2011

% +/-

Revenue (billions)

$15.042

$14.804

1.61%

Days Sales Outstanding

64

59

7.81%

Accounts Receivable (billions)

$10.610

$9.503

10.43%

A/R as % of Revenue

71%

64%

7.0%

Days Sales in Inventory

87

73

16.09%

Inventory (billions)

$10.467

$8.617

17.67%

Inventory as % of Revenue

70%

58%

12.0%

Operating Cash Flow (billions)

$1.589

$1.959

(23.29%)

Source: S&P Capital IQ

Foolish bottom line
Possible sequestration combined with European and Asian economic problems will cause continued pain for this industrial giants going forward. Foolish readers should base investment decisions on earnings quality.

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Fool contributor John Del Vecchio is co-advisor to Motley Fool Alpha and co-manager of the Active Bear ETF. He is the co-author with The Motley Fool's Tom Jacobs of "What's Behind the Numbers? How to Expose Financial Chicanery and Avoid Huge Losses in Your Portfolio." You may follow him on Twitter @johnfdelvecchio. He does not own any shares in the companies mentioned in this article. 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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