Electrified by Eaton, Unplugging Emerson

 | Mar 11, 2014 | 9:30 AM EDT
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Since the market has had a great run over the past 15 months, it makes more and more sense to be discerning with your portfolio holdings. 

We still look for the overall stock market to trade higher, but it is very important to make sure you still have a high conviction in your holdings. Don't be shy about locking in profits.

Readers know that we have been very upbeat about industrials, and by and large we continue to be so for the balance of the year. Industrials continue to benefit from strong secular growth in global infrastructure and transportation spending. Many of the firms have also positioned themselves to benefit from increased energy and power-conservation efforts. Going forward, however, we believe that selectivity is becoming increasingly more important.

Two stocks that we have discussed and recommended a number of times in the past two years are Eaton (ETN) and Emerson Electric (EMR). We liked both companies, and both stocks have done well, although Eaton has far outpaced Emerson.

While both of the stocks have performed nicely, Eaton has done a far better job running its business and growing its earnings. Some of the key differentiating factors of this outperformance are that Eaton has a much better business portfolio after the 2013 acquisition of Cooper Industries. The company is benefiting from renewed efforts to enhance energy efficiency. Eaton is also seeing strength in its cyclical hydraulics and truck-component segments. Most importantly, Eaton is benefiting from multi-year merger and tax synergies as a result of the Cooper deal. Management has outlined several key operating and cost-synergy plans that will reduce costs and boost profits significantly.    

In addition to these better operating metrics, Eaton's stock price is cheaper than Emerson's, on the basis of 2014 numbers, at 15.5x earnings per share of $4.85. Emerson is trading for 17.3x its 2014 EPS estimate of $3.75. Looking at 2015's numbers, Eaton's shares are even cheaper, trading at 13.1x estimated EPS of $5.71. Emerson is trading at a loftier 15.8x 2015's EPS estimate of $4.10.  Consensus estimates have Eaton's earnings growing at 15.5% over the next three years, compared with 9.5% for Emerson. So we believe that Eaton, besides being cheaper than Emerson, is better positioned to deliver much healthier earnings growth.

Emerson is still a solid company. However, we believe that investors have to wait until management rebalances the portfolio to higher-growth areas for the stock to see a strong recovery. The company has stumbled while it has a higher portion of its business mix in the slower-growth network power and climate technologies areas. Emerson's investors also haven't had the added benefits of a major acquisition boosting profits, as Eaton has reaped the benefits from the Cooper Industries acquisition.   

So if you own both companies, consider keeping Eaton and taking profits in Emerson. Eaton has a much better chance of performing better in the upcoming year.  If you only own Emerson, we believe that now is a good time to take your winnings and move into Eaton.

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