One of Warren Buffett's Favorite Stocks

08/30/2012 11:45 am EST

Focus: STOCKS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

It's increasingly difficult to find solid dividend growth at decent valuations, now that income has become the new growth, but this stock exemplifies exactly what investors should expect from a good income and value play, writes Jack Adamo in Insiders Plus.

Eaton Corporation (ETN) is a diversified power management company. It is a global technology leader in electrical components and systems for regional and national power distribution grids.

It also makes hydraulics components, systems, and services for industrial and military use, as well as truck and automotive drive-train and power-train systems. The company has approximately 73,000 employees in over 50 countries, and sells products to customers in more than 150 countries.

We've owned Eaton twice before, but it was during the insanity of the 2008-2009 crash and I sold them, since it wasn't clear at the time that our financial system would survive. Our positions netted us an average gain of 6.6% in an average holding period of less than six months. That's not too bad for a time that felt like the Apocalypse.

Warren Buffett is a long-time fan of the company, and it's easy to see why. It has a great long-term track record, a strong balance sheet, very clean accounting, and is reasonably priced at 11 times trailing earnings. It is expected to grow EPS 11% between 2012 and 2013, which would give the stock a P/E-to-growth ratio of 1, which is a steal, especially for a company with such consistent growth. The shares have more than tripled in the last decade; dividend growth has been 12% per year, compounded, over the last five years, and its current yield is 3.3%.

I'm not a fan of serial acquirers, but Eaton has a long history of successfully integrating smaller companies into its structure. The second quarter's earnings were 3 cents lower due to acquisition charges, but still came in at $1.12—15.5% higher than last year's comparable quarter. In May, Eaton agreed to acquire Cooper Industries, a diversified global manufacturer of electrical components and tools with sales of $5.4 billion for 2011.

At the close of the transaction, Eaton and Cooper will be incorporated in Ireland, giving it tax advantages it would not have in the US. In a rare show of approval for an acquirer, Wall Street actually bid up Eaton shares after the merger announcement.

Due to my trepidation over the current state of the market, we will start with a small position, like most others recently. Buy Eaton Corporation up to $49.
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