Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some industrial companies to your portfolio but don't have the time or expertise to hand-pick a few, the iShares Dow Jones U.S. Industrial ETF (NYSEMKT:IYJ) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of industrial companies simultaneously.
Why this ETF, and why industrials?
The industrials sector is poised to benefit as the world's economies get back on track. As more infrastructure work and construction is undertaken, and retailers keep selling more, many industrial stocks will see their fortunes improve. The U.S. economy is in the midst of turning around already, with unemployment falling. There's more room for improvement, though, in the opinion of Fed chief Janet Yellen, among others.
ETFs often sport lower expense ratios than their mutual fund cousins. This ETF is no exception, with an annual fee of 0.46%. It has outperformed the world market over the past three, five, and 10 years -- and it also offers a modest dividend yield near 1.3%.
A closer look at some components
On your own you might not have selected Deere & Company (NYSE:DE) or Cummins (NYSE:CMI) as industrial companies for your portfolio, but this ETF recently counted them among its 200-plus holdings.
Deere & Company
Deere began way back in 1837 as a blacksmith shop, and today it's an industrial giant, offering agriculture, turf, construction, and forestry equipment worldwide, as well as financial services. It enjoys a market share of about 50% in the U.S. and Canada, but that might end up hurting it, as the Department of Agriculture and others are forecasting weak demand for agricultural equipment over the next year and possibly beyond. Part of the problem is a 45% drop in expected government payments to farmers.
That's the bad news. The good news is that our recovering economy (here and globally) should drive new construction, requiring new equipment. And Deere has been busy upping its investments in research and development, which leads to more efficient equipment that in turn spurs sales.
The company is clearly facing some challenges -- its top and bottom lines have shrunk recently -- but its long-term prospects seem solid. The world's population is growing, and more food will need to be harvested to feed it. Deere offers a 2.6% dividend yield and recently hiked its payout by a hefty 18%. Its P/E ratio is below 10, and it's kicking out increasing free cash flow while also reducing its share count significantly.
Engine maker Cummins can top that 18% dividend hike, though, with its recent 25% hike -- though its current yield, at 1.6%, is still below Deere's. It has also been buying back shares, which has helped bolster its EPS, which has slipped a bit in the past few years. On top of a recent $1 billion repurchase plan, the company just approved another $1 billion.
Cummins is poised to benefit from the growth in vehicles powered by the natural-gas engines it builds -- growth that should be spurred some by Environmental Protection Agency regulations calling for more fuel-efficient vehicles as well as related regulations in Europe and Asia. (Revenue from China grew 21% year over year in the company's first quarter.) Cummins has partnered with Westport Innovations to produce cleaner-running long-haul trucks. It's not without competition, though, as companies such as Paccar are also building cleaner-running vehicles.
With a forward P/E of 14, Cummins seems appealingly priced. It has taken on a lot of debt recently, though, so investors should keep an eye on its ability to pay that down. If the 1.6% dividend isn't too tempting, remember that it's being increased aggressively and that Cummins' payout ratio is still below 30%, suggesting plenty of room for growth. And 25% dividend increases are not instituted by managements worried about future performance.
The big picture
It makes sense to consider adding some industrial companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.