Businesses rarely build products and provide services all by themselves, they’re often receiving components and gaining specific solutions from other companies in the industrial sector.
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The industrial sector is often referred to as the backbone of the economy because firms in the segment provide infrastructure, equipment, transport and related professional services. Their outputs are often used to produce other goods, rather than being directly sold to consumers. These businesses and their products are usually involved in areas such as manufacturing, construction, environmental and engineering.
The performance of the industrial sector is often closely tied to the general state of the economy, as demand for their goods and services depends on increasing economic activity. With projects often requiring large amounts of funds and processes benefiting from economies of scale, the sector has many large established businesses, like those found in the Dow Jones Industrial Index, and is a good choice for investors wanting regular dividends.
Industrial stocks can be the home of technological advancements, but their potential growth is also affected by regulations. They can benefit from government spending on infrastructure and other initiatives. Companies in the U.S. could be helped by the reshoring trend, new spending and tax breaks that come with the Inflation Reduction Act.
Boeing is known for developing, manufacturing and servicing commercial airplanes. It also has segments catering for defense and space systems. The firm managed to grow revenues from US$16.7b to US$19.8b over the year to Q2 2023, but saw core operating margins decline to -2%. Investors might see the increase in free cash flow from negative US$0.2b to US$2.6b over the same period as a more positive sign.
Demand for Boeing’s products has rebounded after the COVID-19 pandemic, but their ability to expand production capacity is limited in the short term and the team needs to deal with a backlog of US$363b in their largest division of commercial airplanes. Q2 2023 saw the delivery of 136 commercial planes, while 460 new orders occurred. Investors should keep in mind that the stock price could be affected if many orders are unfulfilled or delayed.
Caterpillar Inc. ($CAT)
The products of construction equipment manufacturer are divided into three main segments - construction, resources, energy and transportation. In Q2 2023 construction sales amounted to US$7.2b. Caterpillar’s managed to increase sales volumes and pass on higher materials costs to customers in this category to see profits grow 82% over the year. Energy and transportation sales also reached US$7.2b, but had a lower profit margin of 17.6% compared to construction’s 25.2% for the period.
Sales growth was a factor in its 81% increase in profit per share to US$5.67 for the last quarter, but some question whether the firm’s clients can continue to absorb these higher costs could impact its future performance. It can be a good option for those interested in dividends, as the business has increased quarterly dividend per share by 51% since May 2019. Investors should also consider that Caterpillar is quite exposed to energy and resources sectors, which many view as relatively volatile and cyclical compared to industries such as consumer staples.
3M Corp ($MMM)
3M manufactures and distributes a wide range of products, from building materials and adhesives to medical and home cleaning supplies. The stock is suited for investors wanting a firm with a diversified client base, as 3M’s covers firms in the auto care, electronics, safety, construction and consumer sectors. However, plans to spin out its health care unit in the near term will affect its overall product mix.
The business is undergoing a restructuring program in 2023, with a focus on operational efficiency and increased its adjusted earnings per share forecast by US$0.10 in Q2 2023 from between US$8.60 to US$9.10 for the full year. For those looking for extra income as at August 2023, 3M has a track record of paying out dividends to shareholders without interruption for over 100 years. On the other hand, the company’s reputation has been affected by its association with ‘forever chemicals’ that contaminated public water systems in the U.S. and it needs to payout US$10.3b for these lawsuits.
There are several ETF options for investors who want to invest in the industrial sector generally, rather than looking for a specific stock. The iShares U.S. Industrials ETF ($IYJ) is for those interested in companies producing goods used in construction and manufacturing in the U.S. The holdings are also American firms that Vanguard Industrials ETF ($VIS) also convert unfinished into finished products.
The Fidelity MSCI Industrials Index ETF ($FIDU) puts at least 80% of its funds in the MSCI USA IMI Industrials 25/25 Index, which means it could have a higher cash component. Cost conscious investors should also note that it has the lowest fees amongst the ETFs mentioned here, being 0.084% as as 17 August 2023. The iShares Global Industrials ETF ($EXI) is better suited for investors looking to access industrial sector firms across developed markets.
Investors should note that these industrial ETFs usually include businesses that operate in and create goods for the defence sector. Large firms by market cap such as Lockheed Martin ($LMT) and RTX Corporation ($RTX), formerly Raytheon Technologies, can be within their top holdings. Those who don’t want exposure to these companies or defence at all should avoid these investment products.