Following Buffett into Eaton

12/15/2008 1:00 pm EST

Focus: STOCKS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says the Oracle of Omaha has been buying the industrial giant, and he likes it, too.

One major source of leads for our investments comes from what I call “Smart Money.” These are people with extraordinary long-term track records. When I see buying in a company or sector by one of these 500-pound gorillas of investing, I take notice. In the last few years, most of our biggest gainers have come from this source.

Eaton (NYSE: ETN) designs, manufactures, markets, and services electrical systems and components worldwide. Its products are used in power distribution and control, fluids control, and control systems for industrial, mobile, and aircraft equipment, among many others. You might say they’re control freaks.

In the third quarter, Berkshire-Hathaway (NYSE: BRK-B) bought 2.9 million shares of Eaton. Warren Buffett is the chairman and chief executive officer of Berkshire, [which is] also the majority holder in Mid-American Energy Holdings, one of America’s largest electric utility companies. It is safe to say that Buffett is intimately familiar with what Eaton has to offer in electrical infrastructure.

President-Elect Obama has already said he plans massive investment to rebuild our deteriorating infrastructure and put people to work. One of the first areas he mentioned for attention was the electrical grid, which has become ever more fragile in the last few years.

I’ve been looking at several companies in this industry in anticipation of this eventuality. Eaton was high on my list. The Buffett imprimatur was all I needed to push it to the number-one spot.

Like all of Berkshire’s holdings, it has a solid balance sheet and a great long-term track record for steady earnings. The recent market slump presents a chance to start accumulating a position at an attractive entry point.

The company will earn more than $7.00 per share this year, and although 2009 earnings will probably fall closer to $6.00, we’re still getting the stock at [around seven] times earnings.

Even a significant downside earnings miss could not make this a bad buy. The earnings yield (the company’s internal return as a percentage of your investment) is about 15%. That’s as good as you’re likely to see in the current environment, and it’s likely to increase nicely after we get a couple of slow years out of the way.

If that isn’t enough incentive, the stock has a current dividend yield of 4.2%. So, even as the market languishes, you’re being well paid to wait, but I expect significant capital gains in the stock over the next five years. Eaton is a buy up to $46. (It closed at $44.50 Friday—Editor.)

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