Industrials, however, make things that are tangible, useful, and–important for my investing style–understandable. The sector can be considered boring, and thereby overlooked, especially in the mid and small cap areas.
The main pitfalls to investments in industrials are commoditization and cyclicality, lessons in which I have bitter experience. The industrial companies that can thrive and become stronger in the face of those headwinds are ones that have a sustainable competitive edge and give the market a long-term beatdown.
How can you tell if an industrial has an edge if you are not an engineer? The “burden of proof” is on a company to tell a non-specialist why it is a better animal or has a better mousetrap. This information can usually be found in the slide deck of an investor presentation or the Annual Report under “Competition.” Careful: many presentations are littered with how their sector is expected to boom and the implied potential for growth is a tempting siren song, but the bottom line is most companies don’t say why they will take market share over their competitors. I have to give them a pass.
So who clears this hurdle? Here’s a short list, and I’m open to candidates that I haven’t found yet. Remember, I’m talking about companies with a superior product and DNA, but not valuations; so I’m not calling these stocks either cheap or overpriced right now (did I mention I was a buy-and-hold investor?).
Hurco Companies, Inc. (NASDAQ:HURC) makes machining tools, whereby small to medium sized metalworking shops can shape parts for aerospace, energy, or any other application. I’m hoping Hurco’s advantage in this crowded space lies with the built-in software that enables lower-skilled machinists be productive more quickly.
Simpson Manufacturing Co, Inc. (NYSE:SSD) makes mission-critical construction materials, primarily the metal braces that keep the beams of your house together. They have a strong R&D ethic, and are the trusted name in this space, especially in areas with seismic or storm activity. This stock showed up on my screener several times before I could bothered researching them—how could there be a moat in this space? Simpson has made one over the decades, and a high-margin one at that, but it is not bulletproof, and they are seeing some increased competition.
Houston Wire and Cable Company (NASDAQ:HWCC) is kind of a cheat for this list, because they don’t make anything, but they are distributors of wire and cable. This can range from mechanical cable for lifting objects to highly specialized, coated, armor plated, fire-retardant energy cables that make the innards of a power plant or factory hum. They are a distributor with some clear value added for large projects to outsource to them the wire and cable part of the job. Just in time delivery of just the right amount of inventory can be a great value. I’m hoping those services are a path to increasing market share and growth as we put the recession in the rear view mirror.
IPG Photonics Corporation (NASDAQ:IPGP) is awesome, and not just because the founder sounds like a James Bond villain in his heavy Russian accent, or that there are cool YouTube videos of their lasers. IPGP spells out clearly why their product is better, faster, and ultimately cheaper as well. Their industrial lasers are in high demand for existing and ever widening applications, from the auto assembly line and shipbuilding to military and oil drilling. The risks here are valuation and growth expectations (this is the stock routinely with the highest P/E on the list) and increasing competition.
Last, but not least, is Sun Hydraulics Corporation (NASDAQ:SNHY) , which makes the hydraulic valves and systems in mobile applications like construction equipment and fixed applications like industrial robots. It goes without saying that if they are on this list, I believe they have a competitive advantage. Their valves are superior in quality and have a reduced footprint, and I’ll leave you to research the rest. Read the past few years of annual letters to shareholders; they are compelling reading in the small niche of hydraulic-valve-lit (disclosure: I knew nothing about hydraulics before investing in this company). With reinvested quarterly and special dividends, it has quietly grown to my largest investment and thumped the market (which entailed holding through some serious volatility). Watch out hares, this tortoise has got your number.
The article Five Little Industrials With an Edge originally appeared on Fool.com and is written by Anthony Reilley.
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