Wednesday, October 22, 2008
(Cont'd from above)...

I guess you could say that I come out here every night to try to figure out clever ways to try to make money... But, in the end, my elder daughter's college tuition... the money she needs for next year, that I took out of her mutual fund... that's on the line. And bounces like I expect to happen some random day will allow you to join me to hit the exit for that near-term money demand... Five years is near term.

As I said, you must understand that I have to find a way for you to make it through this meat grinder of a market, though, without getting torn to pieces...

How can you avoid getting annihilated, and maybe even make some money in this unrelenting, negative environment?...

Well, the recession has only just begun... Alright, we're still on day one of the battle of the song... so don't you waste your time looking for a large-scale bottom...

The way we get through this is by finding the right stocks and hunkering down in them... almost betting that our first buy will be too early... and buy more, if they go lower, because we're confident that they can make it through this recession.

We want two things from a company right now... A dividend yield that's become sky-high, because of the huge declines, and some proof that the company can handle the recession, because... and this will be the new watchword, the new mantra, the new metric... that you'll hear over and over again for me... because management saw it coming...

Who saw this coming?... You know who has?...

Eaton Corp. (ETN). It's got 'em both!

After taking a skydive from $99 to $39, ETN now sports a fat 5.1% yield. Much better than you can get for cash... And, I know I heard all day today... people said, Jim, Obama's going to come in and he's going to raise rates huge. Look, he's not going to do that, okay. And he's not going to raise taxes... and, if he does, it's only going to be a smidgen... Why? Because it's like the worst economy in years. What is he going to come in, and raise taxes?

Ordinarily, we'd shy away from a company like ETN during a severe economic slowdown. It's an archetypal industrial player, making electrical systems, hydraulics, auto transmissions... all businesses that should get crushed by a weak economy...

But some stocks... we use the term, "discount"... some stocks have fallen too far, too fast... even given their cyclicality... It should be able to make enough money... again talking about the dividend... to sustain its dividend, even if the Street's most pessimistic forecasts are too positive. That's because, ironically, ETN's never gone overboard paying a big dividend. It's always been conscious to have more than enough on hand to pay its shareholders. It's only because of the incredible magnitude of the decline that ETN's once, somewhat puny, conservative dividend has become a big, fat pitch... just like I think Tampa Bay will serve up to Ryan Howard, in the World Series...

Yesterday, we talked about this playbook for the market... how reinvesting dividends is your best bet for preserving, and even growing, your capital... If you buy ETN here, your dividends... well, if you reinvest them... you should double your money in 14 years, even if the stock goes nowhere, thanks to the power of compounding reinvested dividends.

You can figure out how long it will take for an investment to double, using what I call... you might want to write this stuff down... I know, I know, I don't want to be too complicated, but I've got to try every night... It's called the "rule of 72"... If we're talking about a stock with a high yield, just divide 72 by the yield... simple arithmetic... not even math. And the result is the number of years it will take your investment to double through the yield alone, as long as your reinvesting your dividends.

The rule of 72 works for anything where you have compound interest... bonds, savings accounts, you name it... and, in a market with limited upside, like this one, you should be applying it to high yields wherever you could find it.

This isn't just a yield play...

This one works because, unlike other industrials, ETN saw the slowdown coming and prepared for it. The breakdown in the global economy happened quickly. A lot of companies simply weren't prepared.

Last night, when we spoke to Dan DiMicco, the excellent CEO of Nucor (NUE), he said it snuck up on his company but, because he relies on scrap to make steel, and scrap prices are weak, NUE shouldn't be hurt too badly... but it will be hurt...

Because ETN saw the slowdown coming, Sandy Cutler, their excellent CEO, talked about the slowing economy when he came on the show on July 15th... at the top of the commodities... The company can ratchet back production fast enough to be able to make it through even a really protracted recession.

ETN did an equity offering back on April 22nd. People were unhappy about that. It was $84 a share. That's more than twice the current price. But it was to pay down debt... you see, it's a conservative company... giving ETN the balance sheet to make it through this tough recession, slowdown, whatever you want to call it... as long as we don't call it a recession... yet.

On Mad Money, we're going to start measuring management's ability to see through tough times, starting with those who saw this coming, and ETN's Cutler (CEO) did.

ETN actually managed to beat the Street's consensus earnings estimate when it reported its 3rd quarter on Monday. I was waiting to see that before I went out on this. Of course, it lowered its 4th quarter guidance, it slashed projections for next year's earnings... You've got to! If you're an industrial company, you can't say, listen, I'm looking for up-10% next year. That's unrealistic!

It's fine, though, what he did...

We're not buying Eaton Corp. (ETN) because of next year. Oh man... we think it'll stink...

We're buying ETN because it has a big, fat yield, and it we think you can withstand the recession, and we think that the yield allows you to handle the short-term vicissitudes...

Right now, ETN's trading at 2003 levels, where it was at the end of the last recession. But the ETN of 2008 is a very different, better company than the ETN of 2000 and 2002...

Its revenues have nearly doubled, its segment operating margins have improved by over 250 basis points, and the dividend has increased by over 117%.

It's also a very different company... In 1999, ETN's auto and truck division represented 41% of sales. This year, auto and truck - which are just awful, obviously right - are down to 27%. Electric represents 46%. Aerospace, 11%. Hydraulics, 16%. Those are all better businesses...

ETN has really diversified away from the auto and truck space, and become much more of an electrical company that makes products for energy management, greater and energy-efficient... think high-efficiency transformers and capacitors, as well as safety products like circuit interrupters and maintenance switches. Less cyclical...

Since 2000, ETN has done 45 deals to make itself less cyclical, at a pace of 2-9 per year. ETN bought a hydraulics company this month, an auto value company in April... Baumann Electronic in March... two more electrical companies in December of 2007... and another electric business in October of 2007...

Unlike the last slowdown, ETN has much, much, much less exposure to autos. That's why I always used to short this stock when I was a hedge fund manager. I can't short it now. When I was a hedge fund manager, I used to always bet against ETN, at the first sign of economic turbulence. Not anymore.

This company also has more international exposure... A lot of those acquisitions were in Europe... I think it's a more resilient pastiche of a company...

Hey, speaking of dividend increases over the last five years, ETN raised its dividend by an average of 16% annually. We might not see the same kind of dividend increase next year, but I doubt we'll see a cut...

In 2000 and 2002, in a horrible market for auto and truck, ETN held its dividend flat. It never reduced it.

If you are to buy this one, you've got to use the same dividend-based scales I've been talking about. You don't buy it all at once! If you buy it all at once, I'm going to be furious at you! You'll be crying!

Since ETN's at its 52-week low today, yielding 5.1%, you buy a quarter of your position, okay... 50 shares, if you want 200 shares (as your total position)... Then you wait until $36 bucks, and the yield's 5.5%, before buying another 50 shares... Let it go to $33, for the next buy, at 6%, before you pull the trigger, okay...

What you should not do is keep buying the stock if it goes higher...

At $50, its yield is only 4%, and that's nothing to write home about in an environment where so many stocks have become high yielders... but, when these newly high-yielding stocks go back up without increasing their dividend?...

Come on! Sell, sell, sell!...

They're like Cinderella's accessories at the stroke of midnight... You think you're holding onto a diamond, but you're actually holding onto something, well... scatological...

You buy more as ETN goes down. You sell it as it goes up...

Even in the worst-case scenario, though, I think this stock is too low. A good place to start...

If we take the lowest estimates on the Street, and give them a 10% haircut, assuming ETN's sales will decline by 10% next year... pretty drastic, right... its earnings-per-share will be 3% below the lowest estimate on the Street. Say it trades at 9x earnings... the lowest multiple its had in the last nine years... it's a $49 stock... 10 points higher than the current price. At that level, I would be a seller!...

Here's the bottom line!... 


The bottom line!:     Eaton Corp. (ETN) was ready for the slowdown. It is still going to get hit! But you're being paid to take that risk, with
that juicy 5.1% yield, and to hold on until things get better. What is the worst thing that happens? It goes down and you buy more of it, with an even fatter yield.

[verbatim recap]

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