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Stock Strategist Industry Reports

Improved Spending Portends Growth in Automation Sector

Despite their vigorous rebound, we think these stocks still have room to run.

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Since the market trough in March 2009, automation stocks have averaged annual growth near 60%. While this track record will be near impossible to match, there is good reason to believe that these industrial products firms can still perform well as manufacturers bring more capacity on line. An improvement in technology is one of the principle ways to deliver economic growth, presenting an opportunity for manufacturers that specialize in technology improvements.

A Tight Bond with Customers Drives Economic Moat
While the growth story is compelling, we tend to like these firms because of their sticky customer relationships, and value-enhancing products for customers, which lead to stronger, more resilient operating margins. High customer switching costs represent the source of the moat for these companies. Installing an automation platform is timely, and often involves moving many critical processes onto a central control system. The initial growing pains are similar to implementing a new enterprise reporting platform across a large company. With many parts of the system talking to each other, the opportunity for error is large, and the costs of mistakes are higher. As such, many companies elect to stay with an incumbent product for several years, rather than convert to something new, irrespective of the technology improvement.

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Daniel Holland does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.