Gems of the Industrial Sector and What Makes Them Shine

The business news of the last year or two has focused on the impressive performance of the S&P 500, enabled by the extraordinary performance of the 10 largest companies, mainly in the tech sector. Our eyes, however, have been on industrial stocks. To compare their performance, we used our Titanium Economy index to rate companies based on five criteria that are closely correlated with total shareholder returns. When we took a close look at company performance, we found some real gems: 18 industrials that collectively generated returns above those of the S&P and even the 10 largest companies.

The most striking finding is that their exceptional value is not determined by their size or micro-vertical but by skillful management. What makes each company a gem is not who they are but what they do. The top-performing industrial companies excel at pursuing top-line and bottom-line transformation simultaneously, finding a unique market position, expanding margins with adept cash management, developing favorable relationships with analysts and investors, and consistently sharing profits with shareholders through dividend distribution.

Examples of the top industrial companies suggest which actions will enable high performance for any company: managing operating cash flow, employing digital innovation, combining acquisitions and divestitures strategically, engaging consistently and proactively with investors, and nurturing talent to improve results. Companies that master these activities can create the conditions to join the 18 that already shine like gems.

The Hidden Gems

The stock market enjoyed a sustained rally over the past year and a half, with the S&P 500 index surpassing 5,000 for the first time. During the five years through July 2024, the index doubled in value. Leading the charge were the 10 largest companies by market cap: Microsoft, Nvidia, Apple, Alphabet, Amazon, Meta, Berkshire Hathaway, Lilly, Broadcom, and JP Morgan Chase, which now hold nearly 35% of the S&P 500’s total market cap, up from about 19 percent in 2014.

While these giants, predominately in the tech industry, received most of the media attention, the industrials sector also contains some gems, which by comparison escaped notice. Our analysis identified 18 industrial companies that, during the decade from end of 2013 to end of 2023, beat the returns of even the 10 market giants. Over that period, the S&P tripled shareholder returns, and the 10 giants saw an eight-times increase. Remarkably, the top industrial performers grew by a factor of 10 (Exhibit 1).

Exhibit 1

To identify the top industrial performers, we used a metric we developed: the Titanium Economy (TE) Index, which assesses performance in the five areas that are highly correlated with shareholder returns over the past decade. The high-performing companies simultaneously emphasize top-line growth and bottom-line transformation, achieving more than 10% revenue growth and more than 15% EBITDA growth over 2013–23. In addition, they implement differentiated market positioning, which enabled them to beat their micro-vertical’s revenue growth rate by an average of more than 1,100 basis points. They also deliver excellent cash management (free cash flow margin expansion above 550 basis points) and cultivate favorable investor attitudes, and they are consistent in their dividend distribution.

Performance Excellence, Not Attributes

Top performance depends not on who the companies are but the results they achieved. The top industrial performers come in all sizes and belong to 10 different micro-verticals (Exhibit 2). The greater relevance of performance suggests that the opportunity to become a top performer is broadly available to those with strong leadership and a compelling strategy.

Exhibit 2

The outsize performance of the 10 largest companies in the S&P 500 might seem to signal that bigger is better. But in our look at industrial companies, we find top performers across sizes from less than $5 billion in revenues to more than $10 billion. Of the 18 top performers, just three (Builders FirstSource, L3 Harris, and Tesla) are larger than $10 billion, and seven have revenues between $5 billion and $10 billion. That leaves eight, or 45% of the companies, with revenues less than $5 billion. You don’t need to be a giant to excel in the industrial sector.

Similarly, the 18 top performers are spread across 10 micro-verticals. Four provide aircraft and aerospace parts and equipment, and four others sell building products. That leaves 10 companies to operate in eight different micro-verticals as diverse as measuring devices (Teledyne), motor vehicles (Tesla and Winnebago), and logistics (XPO for shipping by air and Old Dominion in trucking). As with size, companies don’t succeed based on the micro-vertical they serve; they succeed by serving it well.

Lessons from the Best

The hidden gems we discovered—the top-performing industrial companies—can be a valuable source of examples for companies that want to emulate their success in value creation. So, of the 18 top performers, we took a deep dive into publicly available information about eight of them: Builders FirstSource, Cavco, Comfort Systems, HEICO, Martin Marietta, Tecnoglass, RBC Bearings, and L3 Harris. 

From their reporting, we observed five value creation levers: 

1. Strategic and focused M&A: Portfolio management sets the direction for the company and ensures that its assets are working toward a clear and compelling objective. M&A that matters will be directed to strategy, typically focusing on the company’s core strengths. For example, HEICO, a leading aerospace and electronics company, completed more than 10 acquisition deals between 2020 and 2023. These acquisitions were a significant driver of the company’s revenue growth at an 11% compound annual growth rate (CAGR).  ‍
2. Diverse end markets exposure: Companies with diverse end markets have an edge in building resilience to perform well throughout the business cycle. When some markets are experiencing headwinds, others may be flourishing. At RBC Bearings, about two-thirds of revenues are generated by the company’s industrial business, with the remainder in the aerospace and defense business. Customers of RBC’s industrial group work in sectors as diverse as manufacturing, mining and metals, aggregate and cement, chemicals, oil and gas, and food and beverages.‍
3. Leadership in manufacturing: Top performers achieve manufacturing efficiency and output quality, both of which require a commitment to continuous innovation. A model example is CAVCO, a leading builder of manufactured and modular homes. The company invests in modern equipment and technology, systematically replacing aging equipment with machines that are safer and less labor intensive. It uses computer numeric control (CNC) machines for precise cutting of components, ensuring accuracy and quality, as well as automated laser beam measurement for price utilities placement. To boost productivity and minimize waste, the company practices lean manufacturing and has achieved high levels of capacity utilization in all production plants. CAVCO also has a safety-first culture and in 2023 reported a 26% reduction in recordable injuries relative to 2022.‍
4. Differentiated product portfolios: Top performers create innovative products, services, and business models to become preferred suppliers. They can improve margins because customers value their ability to provide impeccable precision, rapid response times, or items unavailable from anyone else. Tecnoglass has a robust product portfolio, with high-quality products that are ahead of industry trends. The company recently bolstered its portfolio further by entering the market for vinyl windows, which has major addressable market potential. The current vinyl window operating capacity represents an estimated $300 million in annual revenues once production lines are fully ramped up. This new product line also boosts geographic expansion, given vinyl’s weather adaptability and thermal efficiency for increased energy demands.‍
5. Skilled attention to investor relationships: Top performers cultivate positive investor relationships. Such relationships are built on trust, and to cultivate that trust, companies communicate relevant information regularly and honestly. To engage investors, they also have a compelling story about how the company is meeting and intends to meet real needs. Companies in our sample of top performers build and maintain constructive investor relationships through a combination of foundational initiatives and enhanced engagement. At the foundational level, several have personnel dedicated to investor relationships. For example, Builders FirstSource, HEICO, L3 Harris, and Winnebago each have a head of investor relations to ensure these matters are top of mind. Beyond these basics, top performers enhance investor engagement through providing additional resources, participating in industry conferences, and issuing investor alerts.

How Industrials Can Shine

What can we learn from these examples? Our analysis of the data on top performers plus our experience with industrial companies suggests a few areas to focus on (Exhibit 3): operations management with special attention to cash flow; digital innovation; strategic portfolio management; consistent investor engagement; and practices that improve employee productivity.

Exhibit 3

Like top performers, other industrial companies can remember that cash is king. To excel at cash management, companies can emphasize high performance on their sales-to-operating-cash-flow conversion rate, gross margins, and growth in working capital.

Companies need digital innovation to compete in today’s world. Companies can excel by adopting a B2C mindset in their B2B environment. Like consumer-facing companies, they can invest in state-of-the-art e-commerce to help them offer wide assortments, next-day delivery, and cost and supply-chain transparency.

Industrials can also shine by emulating the portfolio management of top performers, which align M&A with strategy, typically focusing on the company’s core strengths. Top-performing companies achieved approximately 20% revenue growth through five or more accretive acquisitions in the past decade. They align M&A with strategy, typically focusing on the company’s core strengths. Focused companies can aim to build on their focus, whereas conglomerates might do well to consider targeted divestitures for greater focus, which is associated with higher multiples.

Investors are looking for consistent target achievement, so companies should set realistic targets and meet them. Companies that consistently deliver see higher multiples (on average, 3.1 times) than companies that underdeliver on ambitious targets (2.2 times). The benefits of consistently achieving targets include higher valuations and increases in analyst coverage.

Finally, employee productivity is above the norm at top-performing companies, which are, on average, 1.3 times more productive than industrial companies overall. The top-performing companies averaged $480,000 in revenue per employee, compared with $368,000 for industrial companies overall. One key to greater productivity is to foster an ownership culture, using mechanisms like employee stock ownership plans (ESOPs), which are associated with better employee retention.

During the stock market’s sustained rise over the past decade, the 18 top industrial performers outshone even the tech giants that received most of the media attention. They excelled at top- and bottom-line transformation, market positioning, cash management, market attitudes, and sharing profits with shareholders. These accomplishments not only are admirable but also can inform actions that other industrial companies can adapt to their own circumstances. Executives can consider how their companies, too, could pursue value creation through strategic and focused M&A, diverse end markets, manufacturing leadership, differentiated product portfolios, and effective handling of investor relations.