Let It Flow: Profit From These 4 Water Stocks

Water is one of the basic necessities of human life. Life as we know it cannot exist without water. For this simple reason, water may be the most valuable commodity on earth, asserts Ben Reynolds, a contributor to MoneyShow.com, a dividend and growth expert and the editor of Sure Dividend. It is only natural, then, for investors to consider purchasing shares of the companies involved in water. There are many different companies that can give investors exposure to the water business, such as water utilities. Some other companies are engaged in water purification. In all, we reviewed 40 stocks that are in the business of water. Of those, only these 4 are considered buys. Toro The Toro Company was founded in 1914 as an engine manufacturer, providing power to early tractors. The company quickly shifted focus to mowers, where it continues its focus today. Toro will also benefit from growth in the water industry because the company has a large irrigation business, which represents approximately 16% of annual sales. In all, Toro generates annual revenue of $2.8 billion. Toro generates approximately 75% of its sales in the United States. It caters heavily to professional customers, who provide 74% of annual revenue. Toro has generated steady, impressive growth over the past several years. With expected EPS of $2.95 for 2019, Toro stock trades for a P/E ratio of 24.5x. Our fair value estimate is a P/E ratio of 21.5x, implying the stock is overvalued today. This could negatively impact shareholder returns by approximately 2.6% per year through 2024. Still, we expect Toro to generate annual EPS growth of 12% per year, more than offsetting an overvalued stock. In addition, the stock has a 1.3% dividend yield, which leads to total expected returns of 10.7% per year over the next five years. Toro is not a high-yield dividend stock, but its impressive growth and nearly 11% expected annual return give the stock a buy recommendation. Pentair Pentair was a diversified industrial conglomerate. The company recently spun off its Technical Solutions segment and now operates as a pure-play water solutions company that operates in three segments: Aquatic Systems, Filtration Solutions, and Flow Technologies. Pentair was founded in 1966 and trades with a market capitalization of $6.7 billion. Pentair has increased its dividend for 42 consecutive years, when adjusted for spinoffs, which makes Pentair a member of the Dividend Aristocrats list. Pentair recently reported its second-quarter financial results. Net sales rose 2% from the same quarter last year, to $800 million in the most recent quarter. Growth in the Filtration Solutions and Flow Technologies businesses was slightly offset by a decline in the Aquatic Systems segment. Pentair management believes the company can grow EPS by 10% per year over the long-term. We take a slightly more cautious view, with expectations of 6%-7% annual EPS growth through a combination of revenue growth, some margin increases, and share repurchases. Pentair's future growth will be fueled by its durable competitive advantages. Specifically, Pentair enjoys a dominant position with a lean, highly efficient structure. Pentair employs a strategy called the Pentair Integrated Management System -- or PIMS -- which allows its organizational structure to remain lean and encourages efficiency through the company's supply chain and distribution operations. Pentair is a leader in the niche markets it targets, and through tuck-in acquisitions, Pentair can grow its size and scale further. Pentair stock has a 2019 P/E ratio of around 15.7x, which is below our fair value estimate of 18.0x. An expanding price-to-earnings ratio could boost annual returns by 2.8% per year through 2024. Pentair also has a 2% dividend yield which will contribute to shareholder returns. In all, total returns are expected to reach 11.3% per year over the next five years. We rate Pentair a buy for its high expected returns, and its status as a Dividend Aristocrat. A.O. Smith A.O. Smith is also a member of the Dividend Aristocrats list. A.O. Smith is a leading manufacturer of residential and commercial water heaters, boilers and water treatment products. As a result, A.O. Smith is directly involved in the water business, and is a beneficiary of higher demand for water. A.O. Smith generates 64% of its sales in North America, 34% in China and the remaining 2% in the rest of the world. The company has a particularly impressive growth outlook, as it conducts a large portion of its business in emerging markets like China and India. These countries have very large populations and high rates of economic growth, and demand for water will be particularly strong there in the coming years. The company has gained market share in water heaters for 15 consecutive years. It has generated highly impressive EPS growth of 25% per year over the past several years. A.O. Smith reported its second-quarter earnings results on July 30. It was a difficult quarter overall, as A.O. Smith reported an 8% decline in both revenue and earnings per share. The company is facing pressure from the global trade conflict over the past several months. As China represents a large portion of its business, a protracted trade dispute could continue to weigh on the company's financial results. That said, trade issues are typically a short-term challenge. The long-term outlook remains supportive of growth for A.O. Smith. And, it still expects 2019 to be another highly profitable year. A.O. Smith guides for EPS in a range of $2.35 to $2.41 for the current fiscal year. A.O. Smith has grown its earnings per share by 18% annually over the last decade, which is a very attractive growth rate. The company's profits grew relatively consistently during that time frame. Earnings per share declined from 2009 to 2010, but rose during all other years. The last financial crisis did not have an overly large impact on A.O. Smith's profits, as earnings-per-share rose between 2008 and 2009. Importantly, A.O. Smith raised its dividend during every year of the financial crisis. The future outlook is highly positive for A.O. Smith. Thanks to the booming housing market in the U.S. and stronger consumer spending, the company has enjoyed consistent growth in the domestic market. The company is poised to keep growing for years in China thanks to the country's huge population, its robust GDP growth, and its booming middle class. Over the long-term, we believe that A.O. Smith can grow EPS by 9% per year over the next five years. A.O. Smith stock trades for a 2019 P/E ratio of 19.0x, based on the midpoint of its revised full-year guidance. This is slightly below our fair value estimate of 20.0x. An expanding P/E ratio could boost annual returns by 1% per year over the next five years. In addition, EPS growth of 9% and the current dividend yield of around 2% lead to total expected returns of 12% per year over the next five years. This is a very attractive rate of return, making A.O. Smith a buy for dividend growth investors. Consolidated Water The top-ranked water stock is Consolidated Water Company , which was founded in 1973 as a private water utility in Grand Cayman. Since its founding, it has discovered a very nice niche for itself in the water business. The company uses a desalination process that helps provide water where naturally potable water is scarce or does not exist. Consolidated Water has since grown to more than $65 million in annual revenue and a ~$210 million market capitalization. It serves a wide variety of customers in six different countries with 14 plants across its service area. Future growth is highly likely for Consolidated Water. The company won a seven-year bulk water supply agreement from the Water-Authority Cayman, beginning July 1. Additionally, the company completed the expansion of the water production and storage capacity of the Abel Castillo Water Works plant in Grand Cayman. Furthermore, the development of the Rosarito, Baja California, Mexico projects involving the construction and operation of a major seawater desalination plant and distribution pipeline continued to make solid progress. As the largest potable water producing plant in the Western Hemisphere and a major, much-needed new source of drinking water for the coastal region of Baja California for at least the next 37 years, the project will have a sizable moat around it and provide considerable growth for the company. In all, we expect annual EPS growth of 7% per year over the next five years. An expanding P/E ratio could boost annual returns by 6.1% per year over the next five years. Including EPS growth and the 2.4% dividend yield, total returns are expected to reach 15.5% per year. This makes Consolidated Water the top stock for investors interested in gaining exposure to water.

Let It Flow: Profit From These 4 Water Stocks

We reviewed 40 stocks that are in the business of water -- only these 4 are considered buys.

Columnist Conversation

This Weekend on Real Money

Acuity Brands (AYI) Posts Much Better Than Expected Results

Fibocall: Tuesday Morning for 6/30/2020

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.