It's the end of another decade, a good time to sit down and consider what investment themes and related stocks might work with a buy-and-hold strategy over the next decade. In this context, sustainable water and improving water and wastewater treatment, the need to maintain infrastructure in the U.S., and the industrial software that powers the Internet of Things strike me as very attractive areas to invest in. Here's the way to make money from these ideas.

A futuristic stock chart

Image source: Getty Images.

Sustainable water stocks

It's been a great year for some of the stocks in this industry, with strong gains for water and wastewater treatment systems company Evoqua (NYSE:AQUA), and water and environmental consultancy Tetra Tech (NASDAQ:TTEK) -- both worthy contenders as a play on sustainable water -- but it hasn't been one for the stock that I think is best placed to benefit in the long term, Xylem (NYSE:XYL).

The reason comes down to overpromising and underdelivering -- something investors usually punish by selling a stock. Indeed, Xylem has cut growth and earnings guidance through the year and is now behind on its medium-term operating margin expansion plans -- management originally hoped to get to an operating margin of 17% to 18% by 2020 -- and has taken a goodwill impairment charge over an acquisition.

XYL Chart

XYL data by YCharts

That said, investors have to decide whether the issues -- slower-than-expected adoption by utilities of its advanced infrastructure analytics (AIA) solutions, and weakness in industrial and commercial water treatment -- are merely near-term or part of a lasting problem?

Frankly, there's a good case to be positive here. Xylem's AIA solutions -- smart meters, data collection, measurement and analysis -- have a lot of potential to help utilities deal with leakage, theft, network monitoring and metering, but it's understandable if the exact pace of adoption is proving hard to predict.

Moreover, it's not that AIA adoption isn't taking place -- AIA-connected organic revenue grew double digits in the recent third quarter, with orders up 80% -- but rather that Xylem probably expected more. Meanwhile, the slowdown in industrial orders is in line with what a host of other industrial companies have said about the marketplace.

Analysts expect Xylem's earnings growth to recover in 2020, and revenue and earnings should drop into good growth in free cash flow (FCF) in the coming years. Based on analyst estimates, Xylem will be trading at around 20 times its FCF at the end of 2020; that's a good value for a company with high-single-digit growth prospects.

For reference, I've included Tetra Tech and Evoqua in order to demonstrate how attractive the water technology end market is.

Xylem, Tetra Tech and Evoqua earnings estimates.

Data source: Company presentations. Analyst estimates. Lightly shaded areas indicate estimates.

Invest in industrial software

According to leading industry analysts, the big winner from the Internet of Things (IOT) revolution is likely to be the manufacturing sector, with manufacturers increasingly using sensors, controls, and factory analytics in order to better run their physical assets.

You could buy the leading automation and robotics plays as a way to get exposure, and/or you could buy the industrial software companies that power IoT and automation. This is where a company like PTC Inc (NASDAQ:PTC) comes in. The company's ThingWorx platform connects an industrial company's physical assets with its digital assets (used to model and improve performance of the physical assets) and is the essence of the IoT. 

PTC has strategic partnerships in place with the leading U.S automation company Rockwell Automation, Microsoft, and another leading industrial software company ANSYS in place in order to drive growth. As such, management believes it will be generating $700 million to $900 million in FCF by 2024 -- the figures straddle management's optimistic and pessimistic scenarios.

Analysts also believe PTC's cash flow will improve dramatically in the coming years, and if PTC hits its targets, the stock will look very cheap in 2022.

PTC Inc

2017

2018

2019

2020 Est.

2021 Est.

2022 Est.

Free cash flow ($millions)

$110 million

$212 million

$221 million

$227 million

$400 million

$542 million

Growth (year over year)

(30%)

92.7%

4.2%

2.7%

76.2%

35.5%

Price to free cash flow multiple

79.9

41.5

39.8

38.7

22.0

16.2

Data source: Company presentations. Analyst estimates.

U.S. infrastructure maintenance

According to an American Society of Civil Engineers (ASCE) report in 2017, there is a dire need to improve U.S. infrastructure, with $2 trillion worth of spending needed for surface transportation from 2016 to 2025 alone. A failure to do this is seen as costing the U.S. economy up to $3.9 trillion by 2025.

There's no doubt there's pressure on U.S. public bodies and utilities to invest in infrastructure, and that's where small-cap companies Federal Signal (NYSE:FSS) (street sweepers, sewer cleaners, safe digging, road marking equipment, etc.) and Alamo Group (NYSE:ALG) (tractor-mounted mowers, street cleaners, excavators, snow removal equipment) can benefit.

Both companies have generated impressive revenue and earnings growth in recent years; if analyst earnings and FCF projections are correct, then both companies will be trading at 13 to 14 times their FCF generation in 2021 -- that's very cheap for companies with such attractive end markets.

Alamo Group and Federal Signal

Data source: Company presentations. Analyst estimates.

Stocks to buy for the next decade

There's no guarantee that the growth aspirations of Xylem, PTC, Alamo, and Federal Signal will be fulfilled in the next decade, but they all look like they operate in end markets set for good long-term growth -- the key to long-term investing. As such, they are attractive stocks for investors willing to take a long-term view.