Is This Small Stock the Next GE?
Editor’s note: The following article was published on Dec. 6. As one of the most widely-read articles of the year, we decided to share it with our readers once again.
When there’s a slot open for an industrial stock in a portfolio, many investors — even professional ones — automatically default to General Electric Co. (NYSE: GE). “You HAVE to have GE,” I’ve heard them insist, as if not owning GE would be tantamount to investment blasphemy.
Yes, GE is a solid company, and analysts are forecasting good results for it during the next few years, with estimated earnings growth rates of 12.5%, and an increase in cash flow of 8% and 7.5% for dividends. GE’s energy infrastructure segment has been doing especially well, too. In the third quarter, for example, orders were up 15% to $8.6 billion, while operating profits for the first three quarters of 2011 totaled $4.4 billion, a 14% improvement compared with the first three quarters of 2010.
But there’s another diversified company that could outperform GE — significantly — going forward. And I’m seriously thinking of selling all or part of my GE stake and putting the money in this stock instead.
Like GE, this firm has its hand in lots of different segments. This company owns well-known brands such as Craftsman and Armstrong industrial tools. It makes testing devices for many types of electronic equipment, disinfection devices and other products related to water quality; research and clinical tools for use by scientists, along with a range of products and equipment for dental professionals. Fire-suppression systems, electronic security systems and custom motors are among its offerings, too.
I’m talking about Danaher Corp. (NYSE: DHR) — a company that has grown sales, cash flow, earnings per share (EPS) and dividends by double digits through the past decade, even as GE floundered. I think Danaher’s growth could continue at a double-digit pace in all of these categories for at least another three to five years, making it a much more attractive investment than GE.
One reason Danaher should grow faster is because it’s a fifth of GE’s size. With a market capitalization of about $33 billion compared with GE’s $171 billion, Danaher has plenty more room for expansion. Of course, being smaller doesn’t guarantee faster growth, but I believe this generalization will hold true in Danaher’s case because it has a clear strategy to achieve success.
Strong brand presence is a key part of the strategy. Besides Craftsman and Armstrong tools, for instance, the company owns Fluke — the leader in handheld calibration and testing devices for electronic industrial equipment. Gilbarco Veeder-Root, another Danaher brand, is No. 1 in commercial gas pumps and other equipment used in petroleum retail sales. Then there’s Tektronix, which dominates the market of high-end oscilloscopes, which are electronic test instruments used in the telecom-networking industry.
In addition to a strong brand presence, Danaher has been growing through acquisitions, which have been and should continue to be key to the company’s growth. Tektronix, for example, acquired in November 2007 for $2.9 billion, has become a leading revenue generator, helping to boost sales in the test and measurement division to about 25% of Danaher’s yearly total (currently $15.5 billion). In February, Danaher bought medical test maker Beckman Coulter Inc. for $5.9 billion, in order to gain a stronger foothold in the fast-growing diagnostics industry. Management expects the deal to add $0.05-$0.10 in EPS this year, excluding one-time acquisition-related charges. In 2012, the EPS increase could be between $0.25 and $0.30 per share.
Risks to Consider: Although Danaher’s acquisitions have generally been profitable, the related costs may become too burdensome if management becomes too aggressive about acquisition spending going forward. For now, all seems to be well. Operating margins have been strong and stayed in the 18%-19% range for the past decade, despite the recession in 2009. That said, overspending on acquisitions could become a problem in the future, especially if the economic gloom and doom some economists predict comes to pass.
Action to Take –> Because Danaher has been highly profitable for many years while pursuing a strategy of growth through acquisitions, I don’t think management is likely to fall into an overspending trap. Therefore, I believe the estimates analysts have come up with for Danaher’s annual growth during the next three to five years are feasible. These include growth rates of 12% for sales, 13% for cash flow and 14% for EPS.
Estimates for the stock’s performance also seem reasonable. In the next three to five years, the stock could reach $75-$105 a share, which would be good for a gain of 55%-120% from the current $48 per share. Considering my current position in GE, which has been disappointing, and that it’s probably not going to be the fastest-growing industrial stock in coming years, I’m seriously thinking about reducing the position and putting the proceeds into shares of Danaher. I might even go with a portfolio that’s completely devoid of GE altogether.
– Tim BeganySource: StreetAuthority
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