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Investing in Industrial Stocks

By Matthew DiLallo – Updated Aug 1, 2022 at 1:33PM

The industrials sector is the backbone of the economy. It performs three main functions:

  • Manufacturing and distributing capital goods: This includes building products and machinery and providing construction and engineering services.
  • Providing commercial and professional services: This includes environmental and facility services and human resources and employment services.
  • Providing transportation services: This includes operating an airline or railway.
People looking at laptop in a warehouse.
Source: Getty Images

What are industrial stocks?

Industrial companies operate in several subsectors of the economy, providing products and services related to:

  • Aerospace and defense
  • Air freight and logistics
  • Commercial and professional services and supplies
  • Industrial machinery and electrical equipment
  • Construction equipment and building supplies
  • Transportation, including cars, airlines, and railways
  • Waste management

The industrial industry is also known as the secondary sector. The other two main market segments are the primary sector, encompassing agriculture, fishing, and mining, and the service sector, which includes hospitality, consultancy, and nursing.

Top industrial stocks

These industrial stocks offer some of the sector’s best long-term durability:

Company Ticker Focus
Waste Management (NYSE:WM) Waste disposal, recycling, and renewable energy.
FedEx (NYSE:FDX) A global shipping company.
Lockheed Martin (NYSE:LMT) A large defense contractor.
Caterpillar (NYSE:CAT) A leading global manufacturer of construction equipment.
3M (NYSE:MMM) Manufactures a diverse portfolio of industrial products.

Source: The Motley Fool

Waste Management

Waste Management is one of the leading waste management companies in North America. It provides collection, transfer, and disposal services, as well as recycling and resource recovery. The company is also a leading developer and operator of landfill gas-to-energy facilities.

Waste Management provides its services to residential, commercial, industrial, and municipal customers. With demand for waste hauling relatively stable, its business is more recession-resistant than other industrial companies.

Waste Management has invested money over the years to automate its fleet of collection trucks and convert them to run on cleaner, cheaper natural gas. Moves like these have allowed Waste Management to consistently generate free cash flow, giving it the funds to make acquisitions. In early 2022, Waste Management reportedly looked into acquiring recycler Clean Harbors (NYSE:CLH).

The company also routinely returns money to shareholders via dividends and share repurchases while maintaining an investment-grade balance sheet. This strategy of expanding and also rewarding shareholders has enabled Waste Management to create significant shareholder value over the years.

FedEx

FedEx provides customers with transportation, e-commerce, and business services. The company operates a fleet of aircraft and vehicles, logistics facilities, and retail stores that help facilitate the shipment of millions of packages daily. It also offers businesses a host of other logistics and e-commerce services that help to distribute their products to customers.

FedEx produces lots of free cash flow. That allows the company to pay a competitive and growing dividend. It can also repay debt to strengthen its balance sheet and make investments to expand its operations.

FedEx’s strong cash flow also enables the company to invest in innovation. The shipping company is testing autonomous vehicles and delivery services. It’s also making sustainability-related investments. FedEx aims to become carbon-neutral by 2040 while generating compelling investment returns for its shareholders.

Lockheed Martin

Lockheed Martin is a leading global security and aerospace company. It researches, designs, develops, and manufactures advanced technology systems, products, and services, primarily for government customers. The defense contractor has four main business segments: aeronautics, missiles and fire control, rotary and mission systems, and space.

The company invests billions of dollars annually on research and development (R&D) to advance the latest defense technology. It routinely compliments its internal R&D program with acquisitions. The company had hoped to acquire Aerojet Rocketdyne (NYSE:AJRD) to deliver greater efficiency, speed, and significant cost reductions for its customers. However, in 2022, the Federal Trade Commission filed to block that transaction, leading Lockheed Martin to terminate the deal.

Despite that setback, the defense contractor should continue growing in the coming years. Russia’s invasion of Ukraine has more countries in Europe planning to boost defense spending, which should bolster Lockheed Martin’s sales in the coming years.

Caterpillar

Caterpillar is a leading global manufacturer of construction and mining equipment, off-highway diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. The company has three operating segments: construction industries, resource industries, and energy and transportation. It also provides financing and related services.

Caterpillar is working toward making more sustainable equipment. It’s collaborating with companies in the rail, energy, mining, and technology sectors on developing new technologies with lower carbon emissions. For example, it’s working on both battery- and hydrogen-powered locomotives. It’s also developing zero-emission haul trucks and equipment for the mining industry. The focus on sustainability will be a major growth driver for Caterpillar in the coming years as the global economy continues making progress on reducing carbon emissions.

Another major growth driver for Caterpillar is the increasing investment on infrastructure in the coming years. The U.S. is one of many countries that has boosted its spending on projects to maintain and expand highway and rail systems, bridges, and other infrastructure. That should drive more demand for construction equipment.

3M

3M manufactures thousands of products that consumers and businesses use every day. As a diversified company, it operates in four main market sectors:

  • Safety and industrial equipment
  • Transportation and electronics
  • Healthcare
  • Consumer goods

3M's diverse product portfolio enables the company to generate steady cash flow regardless of market conditions. 3M ranks among the best companies in the industrial sector due to its capital allocation strategy. It historically reinvests around 30% of its available capital (operating cash flow plus debt capacity) into expanding the business through research and development, as well as capital investments.

The company typically returns another 30% of its available capital to investors via a growing dividend. The remaining 40% is available to make opportunistic acquisitions or repurchase shares when they trade at an attractive price. The company is a Dividend King with an investment-grade balance sheet.

In conjunction with developing new products ahead of the competition, 3M is also investing in sustainability. The company plans to spend $1 billion over the next two decades to reduce its water usage and carbon footprint.

How to identify the best industrial companies

The strongest industrial companies have diversified operations, low operating costs, and investment-grade credit ratings. Diversification, a low cost structure, and access to affordable debt are important because of the cyclicality of the industrials sector. Economic downturns directly reduce the demand for industrial goods and services.

Industrial companies also need access to affordable debt because their operations are often very capital-intensive. Most industrial companies need to borrow money to buy new capital equipment and build new manufacturing facilities. Another benefit of a low-cost structure is less exposure to rising cost pressures in inflationary environments.

While a company's financial performance is always relevant for investors, companies in the industrial sector need to maintain particularly strong financial positions. Prospective investors should pay close attention to how specific industrial companies fare in times of crisis.

Related Investing Topics

Should you buy industrial company stocks?

The industrial sector's cyclical nature makes industrial company stocks better suited for risk-tolerant investors. As we’ve seen many times in recent years, economic conditions can significantly change almost overnight. But, in a booming economy, industrial company stocks can generate impressive returns for investors. Buy-and-hold investors who are comfortable with volatility can often earn strong returns by owning shares of high-quality industrial companies for the long term.

Matthew DiLallo has positions in 3M, FedEx, and Waste Management. The Motley Fool has positions in and recommends FedEx. The Motley Fool recommends 3M, Lockheed Martin, and Waste Management. The Motley Fool has a disclosure policy.

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