Shares of Honeywell International (HON 0.68%) are flat in 2014, while the S&P 500 has returned an acceptable 6.5%. The industrial conglomerate's underperformance might have some investors confused, because Honeywell has a strong business and continues to grow earnings and revenue.
Despite this underperformance, I think long-term shareholders -- especially those who consistently add to their position to average their cost basis -- are enjoying this lag. It allows them to scoop up shares at a reasonable price. Let's look at why investors should use the recent pullback to buy Honeywell.
Valuation
When analyzing a company, I usually start with its past 12 months of earnings and revenue, as well as its expected earnings and revenue over the next year. This helps to precisely determine whether a stock is undervalued or overvalued.
The company grew earnings by 11.5% in 2014 and is expected to boost them by 11.2% in 2015. The company's trailing 12-month P/E of 17.5 is below the industry average of 19 and the S&P 500 average of 18.5, as well as Honeywell's own five-year average P/E of 18.6, according to Morningstar.
In other words, the stock is not particularly undervalued, but not overvalued, either. Personally, I find that attractive. I don't necessarily want a stock that is priced at a huge discount to the industry or its historical average, which would suggest there is some problem at the company.
Honeywell's forward-looking P/E ratio of 15 is also below the S&P 500's average of 17.5, which is attractive given the 11.2% expected earnings growth next year. The stock is slightly undervalued compared to its peers and itself on a historical basis, which is also attractive.
The company is diversified
Times are great for a company when it has a bulk of its revenue coming from an industry that is growing strongly. However, when if that industry slows down, it can be disastrous for investors.
Honeywell is not in such a predicament. The company's two largest businesses are in aerospace and automation and control solutions, which represented 29.2% and 35.2% of Honeywell's total revenue for the most recent quarter.
Meanwhile, Honeywell's performance materials and technologies and transportation systems businesses respectively brought in 25.7% and 9.9% of revenue in the quarter.
As you can see, the company has its revenues spread out significantly across several different business, three of which contributed more than 25% in the last quarter. This can help when certain segments slow.
For instance, if aerospace slows, Honeywell as a whole will not be doomed. Instead, only about one-quarter of its overall business will feel the slowdown, and that could be offset by another business in a strong cycle.
It's also encouraging that each of these businesses boosted margins in the most recent quarter.
Capital return
In December, the company announced that it would buy back $5 billion worth of stock. If executed near current prices, the company would take in roughly 7% of the outstanding stock. Not too shabby.
While buybacks are nice because they lower the share count, therefore theoretically boosting the value of each share and increasing earnings per share (because net income is now divided by a lower share count), there is something else that I like more about Honeywell: the dividend.
Honeywell has been very effective with its dividend, which currently yields 2%. Consider that over the past decade, the company has not cut the dividend once. With the exception of 2010, when it kept the dividend steady from 2009, Honeywell has raised its annual payout by 7% or more each year, and by a double-digit percentage each year since 2011.
I actually like that the company didn't raise its dividend from 2009 to 2010. It shows management cares about returning capital to investors (otherwise it would have just cut the dividend), but didn't want to be overzealous, either, given the financial crisis of the time.
In Honeywell's Morgan Stanley Laguna Conference presentation, which can be read here (opens a PDF), the company said it plans to return roughly 50% of its cash flow from operations to shareholders in the form of dividends and buybacks over the next five years. The company expects cash flow from operations to be in the $30 billion to $33 billion range for that time period, so it should return some $15 billion to $16.5 billion to shareholders.
Business is going well for Honeywell. In the most recent quarter, the company beat top and bottom-line earnings expectations, boosted its cash flow, and raised the bottom end of its full-year earnings-per-share guidance. With an appealing valuation and growing capital return for investors, this stock looks attractive for the long term.
