U.S. investors shouldn't overlook the investment opportunity in buying stock in German industrial giant Siemens (SIEGY 1.47%). The company has an American Depositary Receipt and currently sports a 2.5% dividend yield. I think it's one of the compelling names in the global industrial sector. Here's why the stock deserves a place in any investor's portfolio.

A smiling person working on laptop that shows multiple graphs.

Image source: Getty Images.

Three reasons to buy Siemens stock

The investment case for the stock is a combination of three key factors:

  • The company's exposure to a diverse range of industries, including healthcare and transportation, gives it earnings and cash flow resiliency through the business cycle.
  • Management is shifting its focus toward exciting growth areas, including automation, industrial software, digitalization, and electrification.
  • Siemens is undervalued on an absolute and relative basis.

End market diversity

Siemens has a somewhat complicated structure. I'll unravel it all for you, so bear with me, but be prepared to read the prefix "Siemens" a lot!

The key point to understand is that it's a combination of businesses managed by Siemens (digital industries, smart infrastructure, mobility, and a loose collection of businesses lumped together as "portfolio companies") and stakes in companies formerly run by Siemens.

The latter includes a 35.1% stake in Siemens Energy (a company combining a 67% share in Siemens Gamesa renewable energy and the former gas and power business of Siemens). In addition, Siemens owns a 75% stake in Siemens Healthineers. For reference, Siemens Energy is an 18.2 billion euro company, and Siemens Healthineers currently has a 50.8 billion euro market cap. Together the stakes are worth around 38 billion euros, compared to Siemens' current market cap of 109 billion euros.

A hand holding a sphere with the word automation on it.

Automation is a key end market for Siemens. Image source: Getty Images.

In particular, earnings and cash flow from Siemens Healthineers and the mobility business (rail infrastructure, rolling stock, traffic systems, turnkey projects) give Siemens stability in uncertain economic times.

Siemens Segment Earnings Before Interest, Tax, Depreciation, and Amortization (Euros) 2020 2019
Digital Industries 2,786 billion euros 3,132 billion euros
Smart Infrastructure 1,594 billion euros 1,670 billion euros
Mobility 1,039 billion euros 1,083 billion euros
Siemens Healthineers 2,807 billion euros 2,931 billion euros
Industrial Businesses 8,226 billion euros 8,816 billion euros

Data source: Siemens presentations.

Long-term growth prospects

The company's growth impetus comes from its digital industries (industrial software, factory automation, process automation, and motion control) and smart infrastructure (electrical products, digital grid solutions, distribution systems, and building products).

The growth opportunity in digital industries comes from the increasing use of automation in production and the digitization of the industrial sector. In other words, the so-called "fourth industrial revolution," or "Industry 4.0." The trend toward automation has long been in place. Still, now that assets and factories are being made "smart" through digitization and the use of Internet of things (IoT) technologies, the trend will only get stronger.

Siemens' industrial software and automation allow companies to digitalize their physical assets and then use analytics and artificial intelligence to improve their performance.

A person working on a tablet in a smart factory.

Image source: Getty Images.

Another exciting growth opportunity comes in the smart infrastructure business, where Siemens is a leader in electrification. This megatrend is driven by the need to increase efficiency by building out digital energy grids. Furthermore, eMobility infrastructure will be built to support growth in electric vehicles. Meanwhile, the pandemic has accelerated the trend toward investment in energy-efficient smart buildings -- not least to ensure they are clean and healthy.

Both segments will bounce strongly in 2021, with management forecasting digital industries' comparable revenue to grow 9% to 11% year over year and smart infrastructure by 5% to 7%.   They are both segments with long-term growth opportunities.

Valuation looks very favorable

The most intriguing thing about Siemens is the question of why its stock is undervalued on an absolute and relative basis? As a rough rule of thumb, industrial conglomerates are usually seen as fairly valued on 20 times their free cash flow (FCF). 

The Wall Street analyst consensus for Siemens' FCF in 2021 is 6.2 billion euros, putting it on a forward price to FCF multiple of 17.6 times FCF, making the stock look like an excellent absolute value.

Moreover, Siemens is cheaper than all its main individual competitors on a current price to FCF basis. This applies whether it's its main industrial software rival Dassault Systemes or automation rivals like ABB, Emerson Electric, Rockwell Automation, and Schneider Electric. Similarly, Siemens is cheaper than its smart infrastructure peers like Honeywell, Johnson Controls, ABB, and Schneider Electric.

SIEGY Price to Free Cash Flow Chart

Data by YCharts

Is Siemens a buy?

Putting it all together, Siemens offers investors a compelling mix of long-term growth potential supported by earnings and cash flow stability. Throw in a 2.5% dividend yield, a rock-solid balance sheet (just 4.9 billion euros of net debt),  an attractive valuation, and bundles of FCF, and the stock remains an attractive buy for investors.