Illinois Tool Works Is A Margin Beast, But The Valuation Is A Little Scary

Maybe the worst thing I can say about Illinois Tool Works (NYSE:ITW) as a company is that it’s kind of dull and that it underinvests in R&D – something management likely would disagree with. Otherwise, we’re talking about an incredibly well-run conglomerate that is very diversified across the globe (albeit a little light toward China) and across end-markets (albeit a little heavy toward auto). Management’s 80/20 system has generated proven results for years and very very few companies can produce these kinds of margins and returns on a sustained basis.

I thought ITW had some “best of the rest” attributes back in April, largely on the strength of its margins, but the shares have done quite a bit better than its peer group since then – climbing more than 15%, handily surpassing the performance of the industrial sector as well as many other well-regarded (or formerly well-regarded) multi-industrials like Eaton (NYSE:ETN), Honeywell (NYSE:HON), 3M (NYSE:MMM), Parker-Hannifin (NYSE:PH). Dover (NYSE:DOV) and Danaher (NYSE:DHR) are among the few to beat ITW’s performance over that period, though Danaher really isn’t a true peer anymore.

At this point, I can’t really sign off on the valuation Illinois Tool Works is getting. Sure, I understand that investors are taking positions ahead of an expected 2020 rebound, and I also get that high-margin stocks get high multiples. I also understand that once the Street picks a favorite/safe haven, they’ll run it to unsustainable valuations (as happened with 3M). So, while I could maybe stretch my valuation methodology far enough to say it’s not hugely overpriced, a mid-single-digit prospective return is just too low for me.

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Illinois Tool Works Is A Margin Beast, But The Valuation Is A Little Scary