Illinois Tool Works (NYSE:ITW), often known as ITW, is one of those brands that you may not have heard of despite it being all around you. Consumer products like zippers in clothing, resealable food packaging, multi-pack ring carriers for beverages, components for automobiles, and fastening systems for construction are just a few of the markets and products that make up this over 100-year-old company's portfolio. Despite 2019 being the largest one-year gain in the stock market since 2013, ITW outperformed both the S&P 500 and the Industrial Select Sector S&P Depositary Receipt Exchange-Trade Fund, or SPDR ETF (NYSEMKT:XLI). Is the run over? Or is Illinois Tool Works stock still a buy?

A laser cuts a piece of metal, sending sparks flying.

Image source: Getty Images.

80/20

You've probably heard of the expression that 80% of a company's revenue comes from 20% of its customers. It's generally a good rule of thumb and one of the many reasons why companies invest so much of their time and money increasing business from existing customers. Reward systems, memberships, and subscription models are all techniques that support this business model. ITW's strategy takes it a step further through a principle it calls "80/20 enabled." According to the company, they "draw deep insights from our key customer relationships, and then focus our efforts on designing and patenting new products and components that solve their specific challenges." It's a mindset that seems to be working, as ITW has amassed around 20,000 patents in total.

Three reasons to buy

There are three main reasons why ITW is an attractive stock. To begin, the company yields 2.3% and has raised its payout to shareholders for 47 years in a row, making it a worthy dividend stock. Third-quarter 2019 operating income was $868 million, free cash flow was $830 million, and cash dividends payable was $344 million, meaning the financial health of ITW is strong enough to be able to afford its current payout.

The second reason is that ITW has seven main business segments, all of which are sizable but not dominant. This is attractive because ITW's success isn't tied to one product or segment, rather, a diverse portfolio of businesses offers different ways to grow and insulate the company during tough times.

Business Segment

Q3 2019 Revenue

Percentage of Total Q3 2019 Revenue

Q3 2019 Operating Margin

Automotive OEM

$744 million

21.3%

22.1%

Food Equipment

$551 million

15.7%

27.5%

Test and Measurement/Electronics

$512 million

14.6%

25.6%

Specialty Products

$441 million

12.6%

26.2%

Polymers and Fluids

$418 million

11.9%

24.1%

Construction Products

$416 million

11.9%

25.1%

Welding

$402 million

11.5%

28.2%

Total

$3.5 billion

100%

25%

Data Source: Illinois Tool Works 

Third, ITW's quarterly operating margin is an impressive 25%, up from a Q1 margin of 23.6% and a Q2 margin of 24.1%. Operating Margin is a profitability indicator that is simply operating income divided by total revenue. Operating income is the result of subtracting the cost of goods and services, also known as the cost of revenue, from total revenue, as well as subtracting selling, administrative, and general expenses like research and development for ITW. ITW also subtracts amortization and impairment of intangible assets.

Operating margin varies significantly from industry to industry. Low margin businesses like Costco  and Walmart  have operating margins less than 5%, whereas tech giants Microsoft  and Facebook  have operating margins around 35%.

ITW Operating Margin (TTM) Chart

ITW Operating Margin (TTM) data by YCharts

ITW's 25% operating margin is excellent for an industrial manufacturer and supplier. In fact, it's one of the highest operating margins of any of its main competitors and higher than all top-ten holdings in the XLI except for Union Pacific (railroads tend to have higher operating margins).

Reasons not to buy

There are a lot of attractive reasons to buy ITW but there are some concerns as well. For example, year-over-year declines in revenue and negative organic growth rates in all but one business segment are concerning. That said, ITW's ability to grow the bottom line 7%  year over year between Q3 2019 and Q3 2018 despite problems with organic growth is a testament to efficiency.

ITW Chart

ITW data by YCharts

Another concern is that ITW's stock price has been outpacing earnings growth, leading to a rising P/E ratio which makes the company less attractive as a value stock.

The verdict

ITW is a premium industrial and a tenured member of the coveted "Dividend Aristocrat" cohort. Although declines in organic growth are concerning and the stock isn't as cheap as it used to be, it's hard to argue against buying ITW for the long-term for a balance of growth and income.