While high flying tech growth stocks may get most of the attention, over the decades boring but beautiful industrial blue chips like Eaton Corp (ETN) have proven to be some of the best long-term wealth creators. In fact, over the last 30 years this little known industry leader has managed to generate total returns of 3,170% compared to the S&P 500’s 1,950% (12.3% vs 10.6% annualized returns). Now of course past performance is not necessarily a guarantee of future returns. However there are three reasons why Eaton is likely to not just be able to match its historical returns over the next decade, but potentially surpass them. Along the way it’s likely to double the market’s total returns.

A Wide Moat Blue Chip

Founded in 1911, Eaton is an industrial conglomerate that produces its products in almost 60 countries and sells them in over 175 nations and territories. It makes mission critical systems for the: electrical, automotive, aerospace, oil & gas, construction, and agriculture industries.

The key to any good dividend stock is strong competitive advantages. Eaton’s stems from three main factors. First, it’s spent over 100 years and tens of biillions of dollars building up a global distribution chain consisting of over 13,000 distributors. In Asia alone it’s increased its distribution chain by 50% in the last five years and plans to boost that 30% more in the next five. This makes it very hard for smaller rivals, with far fewer resources, to compete with it. 

The second advantage Eaton enjoys is that it has customized many of the products it sells its clients, making them tailor made to meet customer’s needs. This creates high switching costs for products that are essential to safe, productive, and profitable industrial operations. And its products, while commanding premium pricing, usually make up just 5% of an industrial product’s total cost, reducing incentive to switch to a rival.

Add to this the company’s globe spanning and highly efficient supply, manufacturing, and distribution network (economies of scale) and you get some of the industry’s best profitability and returns on capital.

Sources: Gurufocus, Morningstar, CSImarketing

Above average profitability and high returns on invested capital are important for two reasons. First, they are a proxy for: quality management, an efficient corporate culture, and good capital allocation. Eaton’s operating and net margins are about double that of its peers, and its return on invested capital is about 33% higher, indicating a very solid leadership that knows how to invest shareholder capital well.

Second, profitability is what drives safe dividend growth. Specifically the FCF margin is most important since free cash flow (what’s left over after running the business and investing in future growth)  is what pays for dividends, buybacks, and repays debt. Eaton is able to convert nearly 10% of sales into FCF and management plans to increase its FCF margin even further in the coming years.

Source: Eaton Investor Presentation

By 2020 Eaton expects its ongoing cost cutting efforts to help boost operating margins by nearly 2% and help drive annual 11.5% EPS growth. Meanwhile its all important FCF margin is expected to go above 10% and drive $8 billion in free cash flow, providing for plenty of buybacks as well as healthy dividend increases. Better yet, analysts expect Eaton’s earnings and free cash flow per share to grow by about 9.5% over the next decade, meaning its ability to reward investors with ongoing capital returns is likely to continue. And while such long-term forecasts must always be taken with a grain of salt, I consider them reasonable given the company’s stable business model and management’s proven ability to grow both organically as well as through well executed acquisitions.