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Consistent, Predictable Dividends in Multi-Industrials

Eaton Corporation is trading at a discount to our fair value estimate.

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Joshua Aguilar: Multi-industrial stocks are generally safe havens for investors seeking consistent and predictable dividends. Five multi-industrial stocks have paid an annually increasing dividend for over 60 years. We cover four in 3M, Dover, Emerson Electric, and Parker Hannifin.

There are several reasons for this consistent dividend-paying dynamic. First, most of these so-called dividend aristocrats are broadly diversified in multiple different end markets. So a company may have exposure to weak end markets at any given time, like aerospace and oil gas. They typically also minimize their downside protection by positioning themselves to more-stable end markets.

Second, these firms also generally sell mission-critical products and services in a business-to-business setting, which arguably positions them better relative to consumer-facing stocks for when the economy does recover. A lot of these companies use a razor-blade strategy, meaning they build a large installed base of equipment to earn years of higher margin aftermarket revenue, which can last several decades into the future.

Third, the U.S. multi-industry stocks we cover are also generally good at managing their free cash flow. Many of these management teams can prepare for a downturn by reducing inventory and more aggressively collecting receivables, as well as extending payables in a downturn.

Finally, high growth value-accretive internal investments are generally going to be less frequently occurring relative to what you might see in a technology company. So many of these companies are going to look to return capital to shareholders in the form of a dividend. We really haven't been concerned with any of these companies cutting their dividend payments because of their current financial pressure. What you might expect to see is the suspension of share repurchases in a downturn, given the uncertain environment, cutting down capex to maintenance levels, as well as minimal increases to a dividend relative to what you might see during the good times.

As for an individual name we like, we point investors to Eaton Corporation. The 4-star-rated stock currently trades at a 22% discount to our fair value estimate. From a total returns perspective over the next five years on average, we think investors can expect about a 9% to 10% range of EPS growth, along with what's currently a 4% dividend and some share repurchases to boot. We like its positioning in the electrical sector market, and we think it's a smart play on industrial infrastructure spending.

We think the market's missing two key points in its validation. One, we think investors aren't creating the firm with fundamental improvements, detriment of margins. And second we're confident that the deal and the sale of its hydraulics business to Danfoss will close, and we think this is a catalyst in the stock that the market's missing, particularly since this is cash that Eaton can use to return to shareholders.

Joshua Aguilar does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.