By Philip van Doorn, MarketWatch
Daniel Acker/Bloomberg
Here’s an eye-opening tweet to start today’s conversation:
During this year’s flight to yield and low volatility, attention has been paid to utility and telecommunications companies, whose stocks tend to pay high dividends. Machinery companies have gotten lost in the mix.
“As we started the year, we saw a lot of opportunity” after a money-losing 2015 in share prices, Kwame Webb, a senior equity analyst at investment-research firm Morningstar, said in an interview. “The stocks were extremely inexpensive. In many cases, they were priced for a recession.”
A look at the four largest machinery stocks in the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.40% , by market capitalization, shows that investors’ quest for dividends may have contributed to this year’s outperformance.
| Company | Ticker | Market capitalization ($billions) | Dividend yield | Total return - 2016 | Total return - 2015 |
| Caterpillar Inc. | /zigman2/quotes/203434128/composite CAT | $51.7 | 3.48% | 34% | -23% |
| Illinois Tool Works Inc. | /zigman2/quotes/208031922/composite ITW | $41.6 | 2.22% | 29% | 0% |
| Deere & Co. | /zigman2/quotes/207941296/composite DE | $27.1 | 2.78% | 16% | -11% |
| Cummins Inc. | /zigman2/quotes/208385233/composite CMI | $21.7 | 3.19% | 50% | -37% |
| Source: FactSet, Oct. 7 close | |||||
The 2016 returns are indeed breathtaking. Webb said that although he was “touting names for clients” in the machinery industry earlier this year, he thinks stock valuations are no longer attractive.
“People are performance-chasing and maybe trying to harvest dividends. After the run they have had, it’s a bit of a head scratcher why [machinery stocks] have continued to soar.”
Kwame Webb, Morningstar senior equity analyst
These earnings-per-share numbers provide insight into why three of them suffered so much last year:
| Company | Ticker | Consensus 2017 EPS estimate | Consensus 2016 EPS estimate | 2015 EPS | 2014 EPS |
| Caterpillar Inc. | /zigman2/quotes/203434128/composite CAT | $3.58 | $3.53 | $3.50 | $5.88 |
| Illinois Tool Works Inc. | /zigman2/quotes/208031922/composite ITW | $6.14 | $5.63 | $5.13 | $4.67 |
| Deere & Co. | /zigman2/quotes/207941296/composite DE | $3.84 | $4.31 | $5.77 | $8.63 |
| Cummins Inc. | /zigman2/quotes/208385233/composite CMI | $7.97 | $8.15 | $7.84 | $9.02 |
| Source: FactSet, Oct. 7 close | |||||
All but Illinois Tool Works Inc. /zigman2/quotes/208031922/composite ITW +1.13% posted big declines in 2015 earnings amid a global slowdown in orders, as oil prices plummeted and mining and construction activity slowed. Analysts expect a slight increase in earnings per share for Caterpillar Inc. /zigman2/quotes/203434128/composite CAT +0.03% next year, with a 9% increase expected for Illinois Tool Works. They expect an 11% drop in EPS for Deere & Co. /zigman2/quotes/207941296/composite DE -0.47% and a 2% decrease for Cummins Inc. /zigman2/quotes/208385233/composite CMI +0.55% .
Finally, here are changes in forward price-to-earnings ratios:
| Company | Ticker | Price/consensus 2017 EPS estimate | Price/consensus 2016 EPS estimate - Oct. 7, 2015 |
| Caterpillar Inc. | /zigman2/quotes/203434128/composite CAT | 24.7 | 18.3 |
| Illinois Tool Works Inc. | /zigman2/quotes/208031922/composite ITW | 19.1 | 15.4 |
| Deere & Co. | /zigman2/quotes/207941296/composite DE | 22.5 | 17.7 |
| Cummins Inc. | /zigman2/quotes/208385233/composite CMI | 16.1 | 10.8 |
| Source: FactSet, Oct. 7 close | |||
So there’s been a vast increase in forward P/E ratios, not supported by earnings growth, save for Illinois Tool Works. Conclusion: You’ve been warned.
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