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Manufacturing Activity on a High: 4 Industrial Stocks to Buy

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The manufacturing sector which accounts for about 12% of the U.S. economy drew the curtains on 2017 with a strong performance, going by the data provided by the Institute for Supply Management (“ISM”). This upbeat performance was driven by a surge in new orders growth, signaling strong economic momentum.

Upbeat Manufacturing Data Instill Optimism

According to ISM, its index of national factory activity surged to a reading of 58.7 in December from 58.2 in November — the second highest reading in six years. The index had hit a peak of 60.8 in September. Notably, a reading above 50 indicates improved factory activity. The average PMI for 2017 was pegged at a promising 57.6. The December PMI indicates growth for the 103nd consecutive month in the overall economy. The sector is in the 16th consecutive month of expansion, with growth noted in 16 of the 18 manufacturing industries.

The New Orders Index, per the ISM, shot up 5.4 points to 69.4 — the highest reading since January 2004, when the index had recorded a 70.6 reading. Further, December marked the seventh consecutive month with a score above 60 — the highest expansion level witnessed in 14 years. The production index was at 65.8 in December, a 1.9 point expansion from November, the highest reading since May 2010.

On a broader note, per the latest data available, industrial production — a measure of the level of output of manufacturing, mining and utilities sectors in a country — increased 3.4% till November, above its year-ago level.

Construction Sector Shows Resilience

Per recent data released by the Commerce Department, total construction spending in the United States was at $1.26 trillion — an all-time high. Construction spending rose 0.8% in November on a sequential basis and 2.4% on a year-on-year basis. Spending on private residential projects improved 1% in November from October levels and also hit the highest level since February 2007. Residential construction improved 1% while non-residential construction went up 0.9%, both compared with October. Outlays on public construction projects rose 0.2% in November from October.

The construction sector has demonstrated stability through 2017 and witnessed sustainable growth amid various challenges. It goes without saying that President Donald Trump was the biggest factor. Investors were expecting faster growth based on Trump’s assurance of significant tax cuts, higher infrastructure spending and lesser regulations.

The trend is anticipated to continue in 2018, owing to improving economy, modest wage growth, low unemployment levels, positive consumer confidence, a tight supply situation and escalating rent costs. Despite the repeated hikes of the Federal Reserve’s interest rates, optimism surrounding the housing market remains largely unaffected.

U.S Economy on the Growth Path

The U.S. GDP expanded at 3.2% in the third quarter of 2017 — the fastest pace of growth in three years. Notably, it is the first time since 2014 that the U.S. economy has witnessed growth of 3% or more for two straight quarters. According to several recent forecasts, U.S economic growth in the fourth quarter is expected to be at or near the solid pace that's been reported in the prior two quarters.

Unemployment in the United States was at 4.1% in December — the lowest rate since February 2001. In December, the country created 148,000 jobs, the 87th consecutive month of job gains. Manufacturing added 25,000 jobs while construction created 30,000 jobs. Overall in 2017, the construction sector added 210,000 jobs, up from 155,000 in 2016. The manufacturing sector added 196,000 jobs during the year, a significant improvement over the 16,000 jobs lost in 2016. The upbeat manufacturing and construction reports as well as positive developments in the labor market and consumer spending are portraying robust picture for the U.S. economy.

What Awaits in 2018?

Lately, there has been a recovery in the mining sector driven by improvement in commodity prices. Miners are resuming capital investments which are translating to better order flows for mining machinery companies. The continuous advancements in technologies applied in agriculture and mining industries keep demand strong for farming and mining machinery. Construction machinery demand will remain strong in the years to come aided by population growth, urbanization, increased energy consumption and an expanding middle class. Further, increasing demand for global infrastructure, such as roads, housing, airports, and energy will help maintain growth.

We believe that implementation of Trump administration’s growth policies, especially the proposed $1 trillion spending on infrastructure improvement, will be a boon for industrial machinery stocks. Further, manufacturing is likely to get a boost this year from $1.5 trillion tax cut approved by the Republican-controlled U.S. Congress last month. The overhaul of the tax code, slashed the corporate income tax rate to 21% from 35%.

Sector Position, Performance

All the machinery industries are broadly clubbed under the industrial products sector. This sector has been outperforming the S&P 500 market in recent times. In the past year, the sector has gained around 25.1%, above the S&P 500’s growth of 18.2%.

Notably, the Industrial Products sector put up a 19.6% growth in earnings in third-quarter 2017 and 22% growth in earnings is projected for fourth-quarter 2017. The sector is expected to deliver double-digit growth in all the quarters of 2018. Per our projections, the sector will log growth of 14% in first-quarter 2018, followed by 13.4%, 10% and 13.1% in the second, third and fourth quarters, respectively. (Read more: Q4 Earnings Season Gets Underway)

We note that the industrial products sector is currently enjoying a place in the top 50% of the 16 broad Zacks sectors. (To learn more visit: About Zacks Sector Rank).

Consequently, investing in the industrial space makes perfect sense at this point. We have selected four industrial stocks which carry a Zacks Rank #1 (Strong Buy) or 2 (Buy) and a VGM Score of A or B. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Our research shows that stocks with an impressive VGM Score of A or B when combined with a Zacks Rank 1 or 2, offer the best upside potential.

4 Machinery Stocks That Fit the Bill

Deere & Company (DE - Free Report) manufactures and distributes agriculture and turf, along with construction and forestry equipment worldwide. The company has a Zacks Rank #1 and VGM Score of B. You can see the complete list of today’s Zacks #1 Rank stocks here.

The long-term expected earnings growth rate for Deere is 8.0%. It has outpaced the Zacks Consensus Estimate in the trailing four quarters, generating a positive average earnings surprise of 19.5%.

The estimate for fiscal 2018 climbed 15% in the past 60 days and moved north by 21% for fiscal 2019. The Zacks Consensus Estimate for fiscal 2018 reflects growth of 18.86% while the estimate for fiscal 2019 reflects growth of 19.88%. The stock has gained 52% in the past year.

Caterpillar Inc. (CAT - Free Report) , the world’s largest construction and mining equipment manufacturer, has a Zacks Rank #2 and a VGM Score of B. The company has a long-term earnings growth rate of 10.33%. The earnings estimates for the company have gone up 1% for 2017 and 2% for 2018, in the past 60 days. The company also has an impressive earnings surprise history, beating the Zacks Consensus Estimate in the trailing four quarters. It delivered an average positive earnings surprise of 53.06%. The Zacks Consensus Estimate for fiscal 2018 reflects a growth of 20.73%. The stock has soared 71% in the past year.

Kennametal Inc. (KMT - Free Report) , is a manufacturer, marketer and distributor of high-speed metal cutting tools, tooling systems and wear-resistant parts. The stock has a Zacks Rank #2 and VGM Score of B. The company has a long-term earnings growth rate of 8.33%. The earnings estimates for the company have gone up 2% for fiscal 2017 and 4% for fiscal 2019, in the past 60 days. The company also has an impressive earnings surprise history, beating the Zacks Consensus Estimate in the trailing four quarters, delivering an average positive earnings surprise of 20.56%. The Zacks Consensus Estimate for fiscal 2018 reflects growth of 67.39% while the estimate for fiscal 2019 projects a growth of 14.32% Its shares have surged 55% in the past year.

Lakeland Industries, Inc. (LAKE - Free Report) manufactures and sells safety garments and accessories for the industrial and public protective clothing market globally. The stock carries a Zacks Rank #2 and VGM Score of A.

The company has been seeing an upward trend in earnings estimate revision. In the past 30 days, the Zacks Consensus Estimate for fiscal 2018 earnings has increased 6% and for the next fiscal has gone up 2%. The Zacks Consensus Estimate for fiscal 2018 reflects growth of 66.98% and 1.69% for fiscal 2019. The company has an average earnings surprise of 20.64% in the trailing four quarters, beating estimates thrice. Its long-term projected EPS growth rate is 10%. The company’s shares have gained 32% in the past year.

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