VALUE ADDED


4 Safe Industrial Stocks

Steven Goldberg

They're not exciting, but shares of these companies remain cheap -- and should thrive even as U.S. consumer spending remains anemic.



Americans won't spend like they used to for years to come. They can't, really. High unemployment, lower household wealth and tight credit make it just about impossible. That's a challenge for consumer companies -- and for the mutual funds that invest in them.

Fortunately, the stock market offers other targets today. Industrial companies, which produce most of their goods for other companies or for the military or the government, don't face the same problems. "Companies are always looking to increase productivity," says Ralph Shive, lead manager of the excellent Wasatch-1st Source Income Equity (symbol FMIEX).

Names such as Apple and Google get all the attention, but you won't find Shive chasing their ilk. "I don't look for sexy or exciting stocks," he says. "I look for cheap, boring stocks that I think will produce good total returns."

Although the U.S. economy matters a great deal to the industrial companies below, they also sell a fair amount overseas -- particularly in emerging markets, the only part of the world currently growing. Shive calls them value-creating companies because they spend a lot on research and development to produce innovative products. All boast sturdy balance sheets.

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Selling military gear to Uncle Sam is a great business. Harris Corp. (HRS) receives three-fourths of its revenues from the U.S. government. The firm supplies a wide variety of sophisticated communications equipment to the Defense Department. Unwarranted fears that the Obama administration would cripple defense procurement, plus the overall stock-market collapse, helped cut the price of the shares in half since May 2008. At $31.48 as of July 27, Harris trades at just ten times analysts' estimated earnings of $3.16 for the company's fiscal year ending June 30, 2010, according to Thomson Financial.

At first blush, Johnson Controls (JCI) seems an odd pick for Shive. It's in the terrible business of selling auto parts. Not surprisingly, it lost money last year. But Shive says Johnson is the best managed of the auto-parts suppliers. "It will be a survivor," he says. What's more, Johnson has two other businesses that are energy-related and have great futures. It's a major maker of batteries for hybrid cars, and it sells energy-saving systems and controls for heating and air conditioning.

At $25.22, Johnson trades at 72 times estimated earnings per share of 35 cents for the fiscal year ending September 30. But analysts expect annual earnings to rise to $1.37 by September 30, 2010, giving Johnson a P/E of 18.

Intel (INTC), the world's dominant computer-chip maker, remains far ahead of the competition. Its huge cash flow allows it to outspend Advanced Micro Devices (AMD) and everyone else on research and development. Intel currently holds more than 80% of the microprocessor market.

At $19.47, the stock trades at 35 times estimated earnings of 56 cents a share for calendar 2009. That's inflated, but the same analysts expect earnings to more than double to $1.10 in 2010as the world economy strengthens, trading at a P/E of 18.

Raytheon (RTN) is a much bigger defense contractor than Harris. It provides technical services, aides in intelligence, and builds missile systems for the military. With more than 85% of revenues coming from the government , Raytheon is well positioned for high-tech warfare that the Pentagon is fighting and preparing for. At $45.58, the stock trades at just ten times estimated earnings of $4.78 for the 2009 calendar year.

Shive does own a few consumer stocks, notably Wal-Mart Stores (WMT) and Home Depot (HD), but he's sticking to those consumer firms that can make money in a sluggish economy. Don't figure him to chase after such stocks on short notice. He does very little trading.

Looking back, Shive says he was pessimistic from the October 2007 start of the bear market until March 9, when stock indexes bottomed, "but I wasn't bearish enough." The fund lost 48%, compared with 55% for Standard & Poor's 500-stock index. Shive held as much as 18% in cash during the bear market, which he thinks is over; now the fund has just 6% in cash.

His concern that the economy and the market could relapse has kept him out of financial stocks. Those stocks have soared of late, but most large-value funds lost much more than Wasatch-1st Source Income Equity during the downturn because they piled into bank stocks and other financial investments.

In all, the fund's record is terrific. Shive's been there since 1996, and over the past ten years, it has returned an annualized 5% -- seven percentage points better per year than the S&P 500. That's good enough to place it in the top 1% among large-value funds, according to Morningstar. It's practically as high on the rankings for the past three and five years. Bottom line: This is a first-class fund for investors looking for a savvy and cautious manager who keeps one eye on the big picture while shopping for cheap stocks.

Steven T. Goldberg (bio) is an investment adviser.




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