The Basics of the Industrials Sector

Worldwide Invest Better Day 9/25/2012
Worldwide Invest Better Day 9/25/2012

This month at The Motley Fool we're committing ourselves to getting back to basics, culminating on September 25 with Worldwide Invest Better Day. With this in mind, my Foolish colleagues and I are opening the floodgates and unleashing vital information to help you invest better. In a previous article, we reviewed stock diversification, a key fundamental of investing. We're looking at stock sectors one by one, focusing today on industrials.

Industrials sector 101
The sector includes companies that provide industrial and commercial equipment and services, transportation, and distribution operations. From construction and farming machinery to airlines, railroads, and waste management, the industrials sector has a broad range of end markets and beneficiaries. The sector also enjoys vast exposure to emerging markets.

How the sector performs
Industrials are considered a cyclical sector, meaning there's less demand for them in a down economy. During a weak economy, the sector usually underperforms. From October 2007 to March 2009, the sector lost 62%, a time when the S&P 500 lost roughly 55%. When the economy shifts from recession to recovery, the sector experiences a boost. For example, during the most recent stock market run-up commencing March 2009 to present, the industrials sector returned 164% versus 132% for the S&P 500. And over long spans of time, industrials generally outperform the market. In the past decade, the sector returned 118% versus 105% for the S&P 500.

Trends in the industrials sector
With the growing middle class in emerging market nations, the world demand for food is on the rise. As developing countries have become wealthier, diets are improving. This is driving agricultural demand and fueling growth for agriculture equipment companies like Deere (NYS: DE) , the world's largest agricultural equipment manufacturer. To further take advantage of this trend in emerging market growth, Deere is slated to build factories in Brazil, India, and China.

Demand for earthmoving and construction equipment for infrastructure build-out in emerging market nations is rapidly increasing. And the needs aren't just an issue for developing nations. For developed markets, the issue isn't building infrastructure; it's replacing what is old and run-down. America's civil engineers give our infrastructure poor marks -- the U.S. now ranks 23rd compared to other countries for overall infrastructure quality. Worldwide infrastructure needs will keep global companies like Caterpillar (NYS: CAT) busy. The Illinois-based company is one of the world's largest construction equipment manufacturers. Caterpillar recently posted a very impressive quarter, which included year-over-year quarterly revenue and earnings growth of 22% and 67%, respectively. The company offers investors an enticing 2.3% dividend and an attractive current valuation.

Another trend that could generate strong corporate profits is the push for energy efficiency. Companies with a technological edge will likely drive favorable returns for shareholders. Despite recent weakness in truck orders from China, engine maker Cummins (NYS: CMI) stands poised to profit from this transformation. Cummins' partnership with Westport Innovations (NAS: WPRT) , one of the few companies with effective natural gas engine technology, allows the companies to outfit and convert diesel engines to run on natural gas, currently a much cheaper and cleaner alternative.

Operating only in North America, Waste Management (NYS: WM) not only disposes of our trash, but also generates energy from it. The company is currently using biomass to power one million homes. Extensive permitting requirements and barriers to entry give Waste Management a competitive advantage and prevent others from polluting its hefty market share. The company's 4.2% dividend doesn't stink either.

Get exposure to the sector the simple way
If you don't have the time, desire, or interest to research industrials stocks, consider a sector-specific exchange-traded fund, or ETF. Sector specific ETFs like the Industrials Select Sector SPDR ETF are helpful when you lack information to devise your own investing thesis. Using the MSCI World Sector Weightings as a benchmark, roughly 10% of your overall stock portfolio should be allocated to the industrial sector.

Build a more bulletproof nest egg
Making a bet the wrong way in the stock market could cost you. By developing a diversified strategy for adding all sectors to your portfolio, you'll sleep well at night knowing that, regardless of what happens in the market, a portion of your nest egg will prevail.

If you'd like to inch toward more details on Caterpillar, check out our brand-new premium research report. In the report, you'll find everything you need to know about Caterpillar, including key opportunities and risks facing the company. You'll even score a year's worth of analyst updates. This offer won't be available forever, so check out the details here.

Join us for more basic investing information and tips on our microsite for Worldwide Invest Better Day. On the site, we've posted lots of great articles aimed at helping you do just that.

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Fool contributor Nicole Seghetti owns shares of Caterpillar. Nicole welcomes you to follow her on Twitter @NicoleSeghetti. The Motley Fool owns shares of Cummins, Waste Management, and Westport Innovations. Motley Fool newsletter services have recommended buying shares of Cummins, Waste Management, and Westport Innovations. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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