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3 Stocks to Build Your Portfolio Around

By Lee Samaha – Updated Apr 8, 2020 at 4:39PM

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Danaher, PPG Industries, and Xylem will give a nice balance to your portfolio.

It hasn't been the happiest of years for investors in paint and coatings company PPG Industries (PPG -0.75%), life sciences and diagnostics company Danaher (DHR -0.63%), and sustainable water company Xylem (XYL -0.67%), but that shouldn't detract investors from looking at them as potential core holdings for a long-term portfolio. Let's take a look at what could potentially make them attractive.

PPG Industries: A boring, but highly profitable business

One of the first things you notice when looking at a list of dividend aristocrats -- companies that have raised their dividends for 25 or more consecutive years -- is that two largest paint and coatings companies, Sherwin-Williams (SHW 0.49%) and PPG are on it. The simple reason for this is that they operate in a highly profitable and growing industry with high barriers to entry.

A stock ticker board.

Image source: Getty Images.

One characteristic of PPG's industry is that the companies in it tend to have a relatively high return on equity, or RoE. This is simply a metric that measures a company's net income divided by shareholder equity (assets minus liabilities). A higher number implies a company is good at generating profit from the money that's been invested in it.

The current market average RoE, excluding financials, is around 12.3%,  and as you can see below, PPG and its peers have consistently generated more than that over the years.

PPG Return on Equity Chart

Data by YCharts

Moreover, a breakout of PPG's end markets shows just why it's generated a lot of value for investors over the long term -- and also why it faces significant challenges in 2020.

PPG's sales by net sales

Data source: PPG Industries, Chart by author.

The aerospace, marine, automotive, and general industrial end markets are all being hard hit by the COVID-19 pandemic this year, and PPG certainly won't be spared. However, as long as people need physical products, coatings will be in demand, and as long as the global economy is growing there will be demand for automobiles, airplanes, ships, buildings, and more.

Put simply, PPG is a leading play on global growth in an industry that's very good at translating investment into profits. All told, if you believe the industrial economy will grow over time, then PPG's price drop could be creating a good opportunity to buy in.

PPG Revenue (TTM) Chart

Data by YCharts

Danaher: A defensive growth company

Danaher is a company that's slowly been transforming itself into one of the leading life sciences and diagnostics plays on the market. The company spun off the bulk of its industrial business in 2016 into a company called Fortive, and then repeated the trick by spinning off its under-performing dental business Envista in 2019. Fast forward to 2020, and Danaher has just completed a deal to buy a biopharma business from General Electric at a very attractive price.

Meanwhile, the company continues to churn out mid-single digit growth across its businesses.

Danaher core revenue growth.

Data source: Danaher presentations. Chart by author. Year-over-year growth.

Ultimately, Danaher's end-market growth depends upon the need for research and development in life sciences and diagnostic testing in the healthcare sector. These markets tend to be relatively insulated from the economy at large, so holding Danaher in unison with PPG makes sense for investors looking for diversification.

Just as with PPG, the recent price drop looks like it's creating a decent entry point into an attractive long-term story. 

DHR Chart

DHR data by YCharts

Xylem: Sustainable water stock

Sustainable water company Xylem lies somewhere in the middle between PPG and Danaher in terms of its prospects being tied to the economy.

A breakout of its revenue by customer helps to explain matters. Clearly, its industrial end market is the most exposed to the economy. For example, if industrial companies are reducing activity, then they will have less need for wastewater solutions, and mining companies will require less de-watering solutions if they are cutting back on capital spending.

However, end demand from utilities in the developed world is likely to be stable, with the growth kicker coming from the need to develop infrastructure in emerging markets. Moreover, in the long term, there is a clear need for industrial companies all over the world to manage wastewater treatment. 

Xylem revenue share in 2019.

Data source: Xylem presentations. Chart by author.

Thinking longer-term, Xylem has a good growth opportunity from its smart advanced infrastructure analytics (AIA) solutions. In a nutshell, they are solutions which help utilities (and also industrial companies) reduce water losses and improve network efficiency and metering through the use of smart technologies and analytics

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends RPM International and Sherwin-Williams. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Sherwin-Williams Stock Quote
$218.44 (0.49%) $1.06
PPG Industries Stock Quote
PPG Industries
$119.33 (-0.75%) $0.90
Danaher Stock Quote
$280.52 (-0.63%) $-1.77
Xylem Stock Quote
$92.04 (-0.67%) $0.62
General Electric Stock Quote
General Electric
$66.60 (-1.25%) $0.84
RPM International Stock Quote
RPM International
$96.05 (3.42%) $3.18
Axalta Coating Systems Stock Quote
Axalta Coating Systems
$23.50 (0.51%) $0.12
Fortive Corporation  Stock Quote
Fortive Corporation
$61.85 (-0.08%) $0.05
Envista Holdings Corporation Stock Quote
Envista Holdings Corporation
$34.32 (-0.14%) $0.05

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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