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Investing in Industrial Stocks

Updated: July 16, 2021, 9:45 a.m.

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.

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 Focus
Waste Management (NYSE:WM) Waste disposal, recycling, and renewable energy
FedEx (NYSE:FDX) A global shipping company
3M (NYSE:MMM) Manufactures a diverse portfolio of industrial products

Source: The Motley Fool

Waste Management

Waste Management (NYSE:WM) is one of the leading waste management companies in North America, providing 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, making the company's business more recession-resistant than other industrial companies.

Waste Management’s revenue and earnings declined slightly as the COVID-19 outbreak hurt the economy, but its revenue and earnings rebounded in 2021 as the crisis subsided. The company was able to blunt some of the economic impact through a continuous focus on reducing costs and becoming more profitable. For example, WM invested money 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 2020, WM paid $4.6 billion for the waste disposal, collection, and recycling services company Advanced Disposal. The company also returns money to shareholders via dividends and repurchases its own shares, while maintaining an investment-grade balance sheet.

FedEx

FedEx (NYSE:FDX) 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 accelerated its push into e-commerce and managed to thrive during the pandemic. In 2020, e-commerce was the primary driver of additional demand for FedEx’s services and is only increasing in popularity.

FedEx is well positioned to continue producing lots of free cash flow. The company pays a competitive and growing dividend, can repay debt to strengthen its balance sheet, and can choose 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, and it is also making sustainability-related investments. FedEx aims to become carbon-neutral by 2040 while generating compelling investment returns for its shareholders.

3M

3M (NYSE:MMM) 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. The company produced solid results through the pandemic despite some of its businesses being significantly affected.

3M ranks among the best companies in the industrial sector due to its capital allocation strategy. Around 30% of its available capital (operating cash flow plus debt capacity) has historically been reinvested into expanding the business through research and development and 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 industrial 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 the COVID-19 pandemic in particular has illustrated, 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 also profit substantially from owning industrial companies' stocks.

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