Wednesday, October 17, 2007

Investing versus Speculating -- UTX

Just a few days ago, I was extolling the virtues of United Technologies and its high level of predictability. Today the company reported outstanding earnings but warned that 2008 earnings growth would be in the range of 10%-14%, at the low end of its heretofore projected average growth rate of 14%. Since UTX has had a good run this year, the traders headed for the door and UTX was down nearly 2.5 points.

If I thought UTX had significantly changes its stripes, I would be selling too, but I don't believe they have. They operate in 4 areas: Aerospace and defense, Otis elevator, Carrier HVAC, and their security division. Few companies in recent years have been as well positioned and running as smoothly as UTX.

Their announcement of slowing earnings growth is reasonable and proper. We believe the US economy will slow in the coming year. UTX derives 50% of their profits in the US, so it is predictable that the company would warn about a slowdown in earnings.

UTX's strength, however, is their inroads into the rest of the world. Think global economy: think Otis Elevators and Escalators. Think energy conservation: think the new line of Carrier Heating and Air Conditioning systems, which is reported to produce energy savings of up to 35%. Thinks Aerospace and Defense where UTX is a leader in jet engines and helicopters. Think terrorism: think UTC security and protection.

Our Dividend Valuation Model suggests UTX has a high probability of reaching nearly nearly $90 per share in the year ahead, even using the company's lower earnings growth targets.
Notice how tight the actual price (blue line) has been over the last 20 years to the model's predicted price (green bars). This very tight fit is suggesting that, even at a slower growth rate, UTX has a lot of room to run.
Good to great companies aren't on sale unless there is some vexation going on. UTX is a wonderful company undergoing a mild case of vexation. We think it will pass.
We own the stock and have owned it for a few years.
The old saying on Wall Street is that the momentum players cut bait and sell to the value players when the timing is poor but the price is right. All the value players have to do is wait Our model is giving us a clear message that UTX's price is right. Unless UTX's earning and dividends slow to single digits, if we are patient enough, time will provide us a nice profit. It certainly is not guaranteed, but the tight fit of the model suggests that it is as good a guess as we can make of what to expect in the year to come.