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General Investing

Priced-In Optimism: A Fine Line In Industrial Equipment

January 15, 2010

The over-riding trend in the industrial equipment sector is one that should be carefully monitored by investors interested in this space.

“I think what is baked into the stocks at the moment is optimism; the worst is over. We’re going to generally start to see revenue growth start to accelerate from here, and I think you are already starting to see that in a lot of the stocks out there right now,” said Edward Borland, managing director and senior research analyst at Next Generation Equity Research, LLC. Borland sees a cloud of unpredictability and a lack of visibility hovering over some of the higher valuations in this space.

“I think in my conversations with various management teams, there is certainly some guarded optimism, but there is also real lack of visibility on the pace of this recovery. Stock valuations reflect a real bullish outlook for 2010, but company commentary does not quite match this euphoria,” he said.

Gardner Denver (GDI), Albany International (AIN) and A.O. Smith (AOS) are three firms Borland favors in this environment, citing all as companies that have undergone significant restructuring and cost-saving initiatives throughout the economic downturn.

“So if you don’t get any improvement in market conditions, earnings are still going to improve, and you can have reasonable confidence in the numbers,” Borland said. “If market conditions do improve, you’ve got a ton of operating leverage in the model and earnings are going to show substantial improvement.”

The analyst contrasts these names with many of the sector’s higher-valued stocks, which risk a bumpy near term if growth does not ramp up as expected by some investors.

“People are right now valuing companies on 2011, even throwing out 2010 and thinking, ‘Okay, 2011 will definitely be a normal year, so let’s value stocks on that.’ That’s the kind of mentality reflected in these valuations,” Borland said. “You could see some significant downside to some of these stocks if growth stays pretty sluggish.”


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