By Jacob Sonenshine

Manufacturing stocks fell victim to the recent market route. They look like better values now.

All three major U.S. indexes dropped on Friday, with the S&P 500 falling 1.7%. The catalyst was that Walmart issued disappointing sales guidance for this year, validating the lingering concern that consumers will likely slow down spending in the face of elevated interest rates. Consumer stocks dropped, but the pain spread to other areas -- including industrials.

The Industrial Select Sector SPDR Fund dropped 2.1% Friday to about $134, extending losses from its record close of almost $144 in late November. The losses were driven by harsh declines for airlines and Uber Technologies.

Manufactures participated. Theoretically, less consumer spending means that all sorts of producers -- auto makers, chip makers, construction companies and others -- will curb their investment in the face of weaker demand. That means they won't purchase as much of the industrial manufacturer's heavy equipment and machinery.

But the dip in manufacturing stocks appears overdone. It is Walmart that saw analysts revise their earnings forecasts lower, while the industrial fund has seen estimates remain almost unchanged in the past few weeks. These are different businesses -- and manufacturers are seeing demand growth.

The reality is that President Donald Trump's tariffs on trading partners and proposed tax incentivizes for U.S. companies to manufacture in the U.S. will spur more domestic projects and investment. Plus, businesses and residents are moving into clean energy power-related products from older equipment. Many businesses are increasing their purchases of automated equipment, which is more efficient. Demand for these newer products will grow, unless the economy slows down so much that businesses need to pause their long-term investments.

"Earnings momentum has been better than average," writes Trivariate Research strategist Adam Parker, who is sticking with his Overweight rating on the industrials sector. Parker notes broad measures of U.S. manufacturing activity have shown growth this year, on easier comparisons from last year, one of the weaker years since the recovery from Covid.

That is partly why industrial stocks are now stabilizing along with the broader market. Monday, the indexes were wavering between flat and up a tick, as was the industrials exchange-traded fund. That is a sign that the selling is almost over. Even if more declines take hold, the ETF isn't likely to fall much below $131, where buyers have repeatedly come in to support it since September.

Buying the broad ETF is a viable strategy, but there are true winners that are beaten down and look ripe for buying. Parker mentions a few of them: Generac, Agco, Quanta Services and Lincoln Electric Holdings.

Another one he mentioned is Eaton, the $115 billion maker of power generation systems. It sells to companies building out data centers for artificial intelligence, utility providers, the aerospace industry and the mobility industry. Sales, which hit $24.9 billion last year, have grown in 11 of the past 13 years, according to FactSet. That is because Eaton is diversified, so when one segment declines, others can rise, and because customers' ongoing shift into Eaton's products help the company grow sales above the rate of broader economic growth.

That can help Eaton achieve what analysts forecast will be 11% annual earnings per share growth over the coming four years, according to FactSet. Sales would grow 7% annually to almost $33 billion by 2028. The expectation is that costs such as materials, wages and depreciation won't rise as fast, supporting profit margins. Management can use the just over $3 billion it would generate in annual free cash flow to buy back stock, enabling earnings per share to rise faster than revenue.

Such growth could do wonders for a stock that now trades at 23.7 times expected earnings per share for the coming 12 months. That is not even two points above the S&P 500' 21.9 times, whereas the stock often trades at close to a 10-point premium when it is more in favor with investors.

Another name to consider, which Parker didn't call out, is Carrier Global, the $60 billion HVAC maker. Carrier is expected to grow sales at about 4% annually through 2027 to $25.3 billion, as customers shift into energy-efficient heating and cooling solutions.

With stable margins and over $2 billion of cash flow, it will also repurchase stock, bringing about the consensus forecast of 14% annual earnings-per-share growth.

That is a solid deal; the stock trades at 21.8 times earnings, a hair below the market. Historically, it often trades above the market.

The caveat is that Trump's tariffs may slightly reduce demand, but the best-in-class industrials can confront the issue. JPMogan analyst Stephen Tusa notes that Carrier plans to increase prices by 6% to 8% on products that see higher import costs because of tariffs. Not all its products are subject to tariffs because only half its sales are in the U.S. and not all of those sales are for products made in China.

Still, given industrial customers' push to invest in all of these new capabilities can keep demand growing. "We expect a durable acceleration of capital investment to develop over the course of 2025," writes Ironsides Macroeconomics' Barry Knapp.

Take a chance on these stocks.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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February 25, 2025 01:00 ET (06:00 GMT)

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