As the stock market races to all-time highs and we see practically every metric scream overvaluation, investors are left with a difficult choice: Invest in overpriced stocks, or sit on the sidelines and hope for some sort of pullback at the risk of missing out on the bull market.
Other investors are scouring the market for sectors that are reasonably priced and look ripe for takeoff. With the election of President Joe Biden, one of those sectors that has received attention are industrial stocks.
Are industrial stocks right for your portfolio? Read on to find out.
What Are Industrial Stocks?
Industrial stocks are a pretty broad category but are essentially any sector related to an economy’s manufacturing, construction and logistics. Industrial stocks can also be those for companies providing services for industrial businesses.
Individual industrial stocks reach a lot of categories, from waste management, jet manufacturing to freight, industrial machinery, and engineering. Because of the sectors mentioned, industrial stocks are also often correlated to the business cycle of an economy.
When an economy is booming, industrial stocks soar as the demand for all of their industries increases. During a recession, however, industrial stocks are some of the first to fall as budgets are cut across the board.
That’s what made them so attractive for investors looking to hop on board the “re-opening play.” The Covid-19 pandemic shut down the economy, meaning many industrial stocks were the cheapest they had ever been. As the economy began to open back up, these stocks predictably surged.
Industrial Stocks May Rise More
While the easy money may have been taken by now, President Biden’s plans may be a catalyst for a larger rise in industrial stocks.
Biden was elected on a platform that promised an infrastructure reinvestment plan that may be the largest in America’s history. When democrats managed to wrestle more control in the House and Senate, it brought that infrastructure plan one step closer to reality.
Many industrial stocks would directly benefit from infrastructure spending, likely as recipients of government contracts and grants that are worth billions. Industrial companies not directly tied to such projects could also benefit from any improvement in infrastructure, as well as the GDP boost that comes with it.
How to Find the Best Industrial Stocks
Many of the largest industrial companies are household names. On the flip side, there is a great deal of variety in the industrial sectors — from Lockheed Martin to 3M. The number of popular industrial companies can make it difficult for investors to decide which stock or stocks to choose.
Some investors may want to steer away from companies tied to the defense industry, such as the above-mentioned Lockheed Martin or Honeywell. That being said, these companies give investors unique exposure to areas that most other companies can’t — defense.
Beyond that, investors should consider all the basics of fundamental investing when choosing an investment. Remember, these are businesses that are very sensitive to the business cycle. You’ll want to invest in a company that can survive a recession in order to enjoy the booming economy after.
Questions to Ask Before You Invest in Industrial Stocks
There are a few things you should keep in mind before investing in a stock:
- What is the debt to equity ratio?
- If it’s a dividend-paying stock, what is the payout ratio?
- Can the company comfortably pay that dividend?
- What kind of margins are these businesses operating within? A business operating on razor-thin margins will have a much harder time during a slowdown than a business that has much larger margins.
Investors should narrow their search to businesses that are poised to directly benefit from any major infrastructure plan that may come out of Congress. Construction and engineering companies are among the sectors that may benefit from an increase in infrastructure. Logistics companies such as FedEx would also likely see growth as a result of more infrastructure spending.
Investors who just can’t decide (or don’t want to spend too much time with bottom-up analysis), there are passive exchange-traded funds (ETFs) that track a portfolio of all the industrial stocks on a specific exchange, such as the S&P 500. This gives investors a simple, low-cost and diversified way to get exposure to this industry.
Top Industrial Stocks
If you still want to delve into individual industrial stocks, then there are two broad categories to look at: value and growth. We’ve highlighted some companies that are worth considering in each area, but these are not meant as investment advice. You should do your own research or seek out the advice of a financial advisor. Don’t have an advisor? Check out Paladin Registry for a five-star advisor that meets your needs.
Best Value Industrial Stocks
Stocks with a low price-to-earnings (P/E) ratio are useful. With these stocks, you pay less to own a portion of a company’s earnings. These companies can pay investors directly out of their earnings through buybacks or dividends.
GrafTech International
One of the lowest P/E industrial stocks in the S&P 500 today is GrafTech International (EAF), a company that specializes in graphite electrodes and petroleum coke. If that sounds like gibberish for you, no worries. These two components are critical elements to the use of an electric arc furnace, which creates steel and other materials for any growing economy.
Seaboard (SEB)
Seaboard (SEB) is another large industrial player with a low P/E. While the name lets you know that they are involved in the shipping industry, Seaboard is actually a very diverse conglomerate that touches many parts of the economy across the agribusiness and transportation industries. Besides shipping, their main business is pork production!
Air Lease Corp(AL)
Last up is Air Lease Corp. Not too hard to guess what this business revolves around: Air Lease Corp deals in leading aircraft. It’s easy to see how this works. In good times, there is more flying and therefore more demand for aircraft. This makes Air Lease Corp a good proxy for the economy opening up and rebounding.
Fastest Growing Industrial Stocks
In contrast to the low P/E value stocks we mentioned, these are companies that generally hold higher P/E ratios, but are aggressively reinvesting their earnings to further fuel their growth.
Lennox International (LII)
Lennox International is a provider of climate-control tools for the heating, ventilation and refrigerator market. This may not sound too exciting, but the company has managed to grow its year-on-year revenues by 30%. Everyone needs to be able to control their air conditioning.
Generac Holdings (GNRC)
Generac Holdings is a backup generator manufacturer and Fortune 1000 company. This is a compelling industry where many businesses rely on generators — an increasing need as changing weather patterns require an emergency power supply. The company has seen its revenue grow by 70%.
Expeditors International of Washington (EXPD)
Last, Expeditors International of Washington is a massive logistics and freight company. Freight and logistics are the lifeblood of the nation, and this company has generated revenues of $8.1 billion last year while increasing revenue by 76% in the first quarter of 2021.
Industrial Stocks and the U.S. Economy
As we have brought up a few times, the industrial stock sector is highly tied to what happens to the U.S. economy.
This makes industrial stocks an excellent way to express an investor’s specific view on where they see the economy going. If you believe that the economy will start booming thanks to a surge of pent-up demand due to closures, then industrial stocks may be a great way to play this belief.
Industrial stocks are also a great way to invest in the view that federal and state governments will go on a fiscal spending bonanza in order to stimulate the economy. Fiscal spending trickles down throughout the economy and almost always leads to increased demand for industrial stock services. Things such as logistics, freight or construction will likely see a boost in such a scenario.
If you believe that we are heading for an inflationary environment, you may also want to invest in industrial stocks. Sure, these stocks aren’t commodities or gold (which tend to outperform stocks during inflationary periods) but many industrial stocks are adjacent to industries that are tied to commodities and real assets in general. Think about the link between construction companies and real estate, which has been a traditional hedge against inflation.
Many industrial stocks, such as Waste Management Inc, are simply necessary for an economy to keep humming along, regardless of what underlying prices are doing. A business with such inelastic demand for its products is exactly where investors should consider parking their money during rising inflation.
Pros and Cons of Industrial Stocks
pros
- Often overlooked, leading to many undervalued opportunities
- Possible inflation-hedge
- Great way to play the “re-opening” theme
- Many sell products that are necessary for the economy, giving them a strong moat
Cons
- Mainly old-world economy, little innovation and many are not fast-growers
- Very exposed to any downturns in the economy
- Industrials are very broad, each company comes with its own unique risks
- Many sub-sectors are ripe for disruption
The Bottom Line: Should You Invest in Industrial Stocks?
Industrial stocks certainly aren’t for everyone. That being said, if you have a particularly strong view on the economy opening up and recovering rapidly after Covid-19 closures, are heavily invested in tech and want some inflation protection, or just want high-quality diversification, you could do much worse than the industrials sector.
As with any investment decision, you should always research each company individually or simply buy a passive index ETF that tracks the entire industrial sector to give yourself diversified and cheap exposure.