Even if they go mostly unnoticed, industrial businesses are the backbone of our country. Their momentum is also rising as lower interest rates have incentivized higher capital spending. As a result, the industry has posted a 36% gain over the past six months, beating the S&P 500 by 13.2 percentage points.
Regardless of these results, investors should tread carefully. The diversity of companies in this space means that not all are created equal or well-positioned for the inescapable downturn. Keeping that in mind, here are three industrials stocks we’re passing on.
Quanex (NX)
Market Cap: $695.7 million
Starting in the seamless tube industry, Quanex (NYSE: NX) manufactures building products like window, door, kitchen, and bath cabinet components.
Why Are We Cautious About NX?
- Earnings per share fell by 9.6% annually over the last two years while its revenue grew, showing its incremental sales were much less profitable
- Capital intensity has ramped up over the last five years as its free cash flow margin decreased by 6.2 percentage points
- Diminishing returns on capital from an already low starting point show that neither management’s prior nor current bets are going as planned
Quanex’s stock price of $15.25 implies a valuation ratio of 7.8x forward P/E. To fully understand why you should be careful with NX, check out our full research report (it’s free for active Edge members).
Kratos (KTOS)
Market Cap: $15.08 billion
Established with a commitment to supporting national security, Kratos (NASDAQ: KTOS) is a provider of advanced engineering, technology, and security solutions tailored for critical national security applications.
Why Does KTOS Give Us Pause?
- Capital intensity has ramped up over the last five years as its free cash flow margin decreased by 6.7 percentage points
- Below-average returns on capital indicate management struggled to find compelling investment opportunities, and its decreasing returns suggest its historical profit centers are aging
- Diminishing returns on capital from an already low starting point show that neither management’s prior nor current bets are going as planned
At $90.75 per share, Kratos trades at 137.4x forward P/E. Read our free research report to see why you should think twice about including KTOS in your portfolio.
Emerson Electric (EMR)
Market Cap: $74.96 billion
Founded in 1890, Emerson Electric (NYSE: EMR) is a multinational technology and engineering company providing solutions in the industrial, commercial, and residential markets.
Why Are We Wary of EMR?
- Flat sales over the last five years suggest it must find different ways to grow during this cycle
- Free cash flow margin dropped by 4.9 percentage points over the last five years, implying the company became more capital intensive as competition picked up
- Shrinking returns on capital suggest that increasing competition is eating into the company’s profitability
Emerson Electric is trading at $132.99 per share, or 20.9x forward P/E. Dive into our free research report to see why there are better opportunities than EMR.
Stocks We Like More
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