The 5 Best Industrial Stocks to Buy for 2020

Assuming the economy avoids a protracted slowdown next year, these companies' catalysts could deliver strong gains for investors.

While buying top-quality stocks and holding them for at least three to five years is a sound core investment strategy, it's undeniable that the entry point -- the price at which one buys a stock -- will be a key factor in that person's overall return in investment.

One way to gauge those entry points is by considering how other investors are likely to be viewing a stock in a year's time. If the stock's future profile will show a company about to set upon a long-term growth trajectory, and it's trading at a reasonable valuation, then it's a safe bet that the market will be buying the stock. With this approach in mind, here are five large-cap stocks that could look a lot better exiting 2020 than they do entering it.

Looking ahead

The following table is a brief look at what investors can expect in the coming year, some of the catalysts that could make their stocks soar, and the potential risks they face in the near future. 

Data source: Author's analysis. 

Valuations are attractive

Growth prospects are one thing, but to be an attractive buy, a stock must be trading at a good value relative to those growth prospects. So for context, here's a chart of all these stocks' forward price-to-earnings ratios, based on analysts' consensus estimates.

With the exception of Danaher, they all look reasonable. But here's the thing about Danaher: It operates in the highly rated life sciences and diagnostics markets, and its relative free-cash-flow-based valuation looks good.

Moreover, Danaher is about to buy GE's biopharma business for a net price of $20 billion -- a unit that generated $1.1 billion in free cash flow. It's therefore paying 18 times free cash flow for an operation it believes will add $1 in EPS by the fifth year after the deal closes -- and Danaher is on track for $4.75 in EPS in 2020. Frankly, this acquisition looks a great value, and not least when you consider that peers in the life sciences & diagnostics industries (see chart below) trade at much higher price to free cash flow ratios.  

Don't be afraid of the trade war

If the trade wars continue or get worse, or if the economy goes into a recession -- or if both happen concurrently -- all of these companies' prospects would be hurt to some degree. However, of the five, UPS and PACCAR would be particularly exposed to those threats. That said, UPS appears to have made progress with a program of capital spending that's aimed at improving its network and enabling it to better serve the growing e-commerce segment.

The company's margins expanded in the third quarter, and it has even started dialing back its planned capital spending. If UPS can continue to do that over the next couple of years, then it could get back to converting nearly all of its net income into free cash flow -- a positive outcome for investors.

In the case of truck manufacturer PACCAR, a protracted economic slowdown and/or trade war would put a drag on demand for freight hauling capacity, and therefore take a bite out of truck sales. Absent those headwinds, though, there's an argument to be made that the anticipated slump in truck sales in 2020 will merely be a natural correction after a couple of years of strong growth, which in turn came on the heels of the 2015-2016 decline in demand that was caused by a slump in commodities prices.

If that thesis proves accurate, then PACCAR's current price-to-earnings ratio of 14.8 would not be a high valuation for a cyclical stock at the low point of its earnings.

Boeing and Raytheon

You win no prizes for correctly guessing that returning the 737 MAX to service is Boeing's key priority for 2020 -- the issue has been hanging over its commercial aircraft segment. That's a pity, because performance in its other two main segments has significantly improved in 2019. Moreover, the underlying environment for commercial aviation remains good, and Boeing remains a more attractive stock to buy than Airbus. 

Data source: Boeing presentations.

If you can tolerate the uncertainty over the 737 MAX, then Boeing stock is worth buying.

The case for buying Raytheon stock, by contrast, is based on the idea that shareholders will end up owning Raytheon plus the aerospace businesses of United Technologies (NYSE:UTX), which are on track to come together in a new company, Raytheon Technologies.

The acquisition looks like a wise move on Raytheon's part because UTC's aerospace businesses (Pratt & Whitney and Collins Aerospace) are firing on all cylinders right now. Also, while the post-deal ownership split appears to be a fair representation of the two companies' near-to-mid-term cash flow -- Raytheon shareholders will get 43%, and UTC shareholders 57% -- it's probably a better deal for Raytheon, as it might not fully reflect the long stream of earnings to come from Pratt & Whitney's geared turbofan engine on the Airbus A320 NEO.

Looking ahead

If the U.S. economy goes into a recession, then all of these stocks are likely to underperform. But if you believe that 2020 will be a year of moderate, stable growth that leads into a more of the same in 2021, then you should give all of these companies serious consideration. In one year's time, they should all be looking at uptrends in revenue and earnings.