The stock market has been quite choppy in recent weeks, and concerns are growing that the six-year bull market may be at an end.
But catalysts for further upside remain: valuations in the energy sector have fallen along with oil prices and many of the world’s largest central banks are still pumping money into their economies to fuel growth. Even in China, where slowing growth is causing chaos in commodity prices, economic growth remains solid, with the government taking steps to boost the economy.
This environment creates a perfect stock picker’s market. Instead of a one-way bet on higher prices, investors will need to hedge market weakness by picking the losers along with the winners. Pairing your long positions against shorts offers the opportunity not only to hedge lower prices but gain on both sides of the trade.
And two stocks in the relatively expensive tool and accessories industry may offer the perfect paired trade opportunity.
Using The Right Tools For A Long-Short Strategy
Within its coverage universe, Morningstar found tools and accessories to be one of the most expensive industries, at 1.47 times its fair value estimate. One company in the group still offers upside, as it is well-positioned for an eventual acceleration in global economic activity. Meanwhile, another stock in this industry trades at almost a 20% premium to the peer group, and could see weakness on slowing domestic growth.
Snap-on Incorporated (NYSE: SNA ) reports sales in four segments, with tools accounting for 37% of total sales, followed by industrial (30%), repair systems (28%) and financial services (5%). The company books two-thirds (65.5%) of its sales in the United States, followed by Europe (20%) and just 14% from all other regions combined.
Exposure to the U.S. market has increased over the last two years while sales abroad have stumbled. The company has made it a priority to increase exposure to emerging markets which could mean higher capital spending and competition over the next few years. Shares trade for 21.7 times trailing earnings and 18 times expected earnings for next year.
Stanley Black & Decker (NYSE: SWK ) offers greater global diversification than Snap-on. Sales from the United States are 49% of total revenue, with Europe contributing 25% and another 17% from fast-growing emerging markets. However, it is not as well diversified in terms of its business segmentation. The company is #1 or #2 in every segment in which it operates, with tools and storage accounting for 62% of sales, followed by security (20%) and industrial (18%).
SWK increased its market share in tools and storage to 15% in 2014 — more than twice the 6% market share held by Snap-on. Brands from SWK, such as Stanley, DeWalt and Porter Cable, are some of the best you’ll find in tools. Shares trade for 18.2 times trailing earnings and 16 times expected earnings for next year.
Both companies offer continued exposure to upside in the American housing and automotive markets but Stanley Black & Decker offers greater international diversification and with lower valuations. While U.S. economic growth has been the stand-out over the last couple of years, higher interest rates and a weaker employment picture could translate into faster growth overseas. The valuation on shares of Snap-on is looking stretched, especially with analysts expecting sales growth of 6.6% next year, which is likely to be lowered given compound growth of 4.6% over the last three years.
Risks to Consider: Both tool makers may stumble on general market weakness. Stanley Black & Decker should outperform but may experience short-term losses but has greater long-term upside thanks to the valuation discount .
Action to Take : Consider shorting shares of Snap-on against a long position in Stanley Black & Decker to protect your position against general market weakness and benefit from faster international growth.
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