The Case For The Industrial Sector

By James Brumley | July 27, 2011 AAA

While the energy and materials sectors have posted the largest earnings improvements for the second quarter, with the technology sector giving us the best beat/missed ratio so far, it's easy to understand why investors have been a little more interested in those groups than others over the past couple of weeks.

TUTORIAL: Industry Handbook: Porter's 5 Forces Analysis

There's another sector with solid Q2 numbers, however, that you may want to make a point of exploring.

Hard to Define, Easy to Love
It's a bit of a catch-all grouping, but the "industrials" have been significantly stronger than most other sectors so far this earnings season (with the noted exceptions of tech, materials and energy, with the latter two being beneficiaries of rising commodity prices).

How strong? The 35 industrial stocks in the S&P 500 that have reported Q2 results so far have averaged a 22.1% Year-Over-Year (YOY) improvement in earnings. While seven of those names (quite a few on a proportional basis) fell short of estimates, 27 topped their estimates.

General Electric (NYSE:GE) was one of the 27, turning in profits of 34 cents per share for last quarter, 2 cents above analysts' forecasts. Dover (NYSE:DOV), which makes everything from hydraulics to balers to drill bits, was another big winner in Q2 2011. Earnings per share (EPS) of $1.31 easily topped estimates of $1.15. It was the ninth straight earnings beat for Dover, and the 10th consecutive beat for GE.

The successes of those multi-line manufacturers being noted, all of the major industry groupings in the industrial sector have posted solid numbers. These include capital goods with a 22% improvement in earnings, services (think waste management and construction) with a 15% increase in Q2's YOY comparisons, and transportation, also with a 22% bump-up in bottom lines. Boeing (NYSE:BA), for instance, beat estimates of 97 cents per share by turning in a per-share profit of $1.25 for its Q2. That was 18% better than the year-ago figure and the seventh beat in a row. (For more on earnings, see Earnings Forecasts: A Primer.)

Next Step
One of the challenges with buying a sector-based ETF is that when it's all said and done, it often doesn't perform any differently than a broad market or index-based fund. There's enough of a difference - a persistent difference - in these results, however, to give an industrial fund like the Vanguard Industrials ETF (NYSE:VIS) or the SPDR Select Industrial Sector Fund (NYSE:XLI) a fighting chance at a meaningful amount of alpha, or relative outperformance of the broad market.

Still, the path to even more profits at greater risk, of course, is an individual stock. Traders looking for a good buy and hold name should make a point of seeking out an industrial name, even if nobody's talking about it, as the group has been tested and proven - much more so than most other groups right now. After all, according to some theorists, being in the right sector is 49% of the stock-picking battle. (For more on sectors, see Sector Rotation: The Essentials.)

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