FEATURE

| SATURDAY, DECEMBER 18, 2010

It's a Snap! The Profits of

Invention
By SANDRA WARD | MORE ARTICLES BY AUTHOR

Wall Street hasn't noticed, but giant Illinois Tool

Works is poised to profit handsomely from its
product innovation and global expansion. Time to
zip-lock a winner.
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For nearly 100 years, Illinois Tool Works has been a fixture on
the American industrial scene, and as it approaches its centennial
year of 2012, its prospects look as enticing as ever.

The inventor of a popular type of zip-lock bag, the plastic six-pack

ring holder and the interlocking buckles that fasten a multitude of
 items from luggage to backpacks to life jackets, ITW plays a
significant role around the world in packaging, transportation,
construction, power systems and electronics and food-equipment
manufacturing. Its customers are some of the biggest companies in
the world across a broad array of product lines and include
Caterpillar, John Deere, Tata Group, Nike and Chevrolet, among
many others.

With a market capitalization of $26 billion, it is a powerhouse of

invention. It boasts some 19,000 active patents, with more than
2,245 issued in just the past two years.
View Full Image
View Full Image

Barron's Graphics

Illinois Tool Works' buckles fasten everything from luggage to life jackets.

This year, ITW has thrown even more weight into innovation,
boosting spending on research and development, marketing and
product development by 15% from 2009. It plans similar annual
increases in the next five years because management believes
"leveraging innovation" is as critical to defending its existing
businesses in the competitive global environment as it is to its
future growth.

With roughly 800 businesses serving a set of diverse industries,

ITW remained profitable in the difficult year of 2009—despite
suffering steep revenue declines—and revenue and earnings have
come roaring back this year. A combination of cost-cutting and
powerful strength in industrial production—growth in U.S.
industrial production is expected to be around 6% this year,
outstripping an estimated 3% rise in gross domestic product—has
put ITW on track to report total revenue growth of 13% to 14%,
including acquisitions, for 2010.

Earnings are expected to be up nearly 60% from the year-ago

period. Standout sectors included transportation, expected to be up
20% this year; industrial packaging, considered a bellwether for
the overall economy, up about 13% to 14%; and electronics, up 60%
to 65% from the year-ago period. Welding, with a focus on heavy
equipment and agricultural customers, is on track to deliver gains
of 8% to 9%.

As Western economies continue their recovery and Asian and

emerging-market economies continue to expand, revenue and
earnings growth at ITW should continue to be robust. About 87%
of ITW's sales are tied to markets that do well in the early and
midstages of economic expansion. The company is famous for its
finely honed "80/20" business model, in which 80% of its sales are
derived from 20% of its customers, and it works to keep its
business units small as a way of better managing those important
customer relationships.

Acquisitions are a major contributor to growth at ITW and the

company has earned a reputation as a disciplined buyer of assets,
 one that isn't prone to overpaying. The current focus is on
acquiring companies that immediately position ITW on the leading
edge in innovative, high-growth markets. In the past five years, for
example, ITW has entered three new areas through acquisitions
that have contributed mightily to its recent success: the automotive
aftermarket, testing and measurement equipment, and electronics.
Its goal is to add three more platforms for revenue growth between
2011 and 2015.

Recent Price $51.65

52 Week High-Low $52.72-40.33
Market Value (bil) $26.0
EPS 2010 E $3.09
EPS 2011 E $3.68
P/E 2011 E 14.0
Dividend Yield 2.6%
E=Estimate Source: Thomson Reuters
Revenue growth for 2011 is expected in the range of 5% to 7%, and
acquired revenue growth should average 5% to 7% over the course
of the next five-year cycle. Operating margins are expected to
exceed 2006's peak of 17.3% by 0.50 to 0.70 of a percentage point
as early as 2012.

TECHNOLOGY TRADER
| SATURDAY, DECEMBER 18, 2010

Beyond Gadgets: The Services

Brawl of 2011
By TIERNAN RAY | MORE ARTICLES BY AUTHOR

Tech companies like Apple are increasingly

focusing on content and services, not just gear.
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The elephant in the room—all the cash in tech companies' coffers—
will get even bigger next year. Do tech's titans really need to be
acting like they grew up in the Depression, hoarding their dough?
And will they eventually spend it wisely? Or foolishly?

Apple (AAPL), to take just the most absurd example, holds some
$51 billion in cash and equivalents. Google (GOOG) had $25
billion in cash and marketable securities at last glance. Neither
pays a dividend and neither has made any share repurchases this
year. Nor have they ever done much, for that matter.

Apple's cash may rise to $72 billion this year, according to a report
that Gabelli analyst Hendi Susanto put out Friday. That's $78 per
share in cash, perhaps going to $103 in 2012, Susanto estimates.

In a note back in November, Legg Mason's Bill Miller wondered

aloud why companies don't pay out as much as 70% of their free
cash flow, which would allow for dividends of 5% to 7%, while still
providing for ample working capital and money for acquisitions.
Morgan Keegan's Tavis McCourt put out a similar think piece back
in September, writing that cash hoarding is destroying equity
value. McCourt argues that boards and CEOs may in coming
months or years decide that competing for growth investors isn't
the best way to boost the stock price. Instead, they may opt to go
after the growing demographic of retirement-bound income
investors who embraced the bond market in the past decade.

Nice theory, but don't bet on it. Though the cash hoards will seem
even more ridiculous next year, reasons for companies to hold onto
their war chest will increase markedly. Apple, for one, will need to
invest to meet a major challenge. No matter how many iPads and
iPhones it sells in 2011, the competitive focus is shifting to the
"ecosystem." This comprises not just computing devices and
software, but also "services," which basically means content and
functionality that is hosted on Apple's own computers in its data
centers.

Apple is already the No. 1 online music vendor in the world, serving
up content from iTunes. That's a start. But it will have to show it
can go head-to-head with Google, which has spent many more
years hosting individuals' data and thinking about the Internet, not
desktop applications.

In response, Apple is investing $1 billion in a data center in North

Carolina and it is widely expected that the facility will enhance
Apple's current MobileMe online application. It could, for example,
become a big jukebox in the sky, where a customer's movies and
music are stored permanently, rather than residing on their Mac
computer.

APPLE IS CERTAINLY GEARING UP for big investments. Its

capital expenditures are expected to jump more than 55% this year,
to $4 billion, according to Caris & Co.'s Robert Cihra, mainly for
online infrastructure.
Apple, Google, Microsoft (MSFT) and most other computing
companies are competing to build a platform, in the words of Piper
Jaffray analyst Gene Munster. The platform means all manner of
content and computing functionality can be pushed to various
devices, increasingly mobile devices such as tablet computers and
smartphones, while the data resides in the "cloud."

The cloud is tech-industry argot for collections of server computers

managed by service providers, rather than maintained by the
individual.

"The thought of Apple being a consumer-electronics company 10

years ago was absurd," Munster observed in a phone interview last
week. "It's no longer absurd. Now, is it absurd to think of Apple as
a Web company?"

The big question is, Why? Why not just sell computers and
smartphones? Why become a "services" company? One answer is
lock-in. Apple and Google know that by holding your data in the
cloud, so to speak, they'll retain your loyalty for their software and
devices. The defection of customers to other vendors will decrease,
or so the thinking goes.

Another answer: 2011 will bring more and more pressure on tech
companies to compete with the new kids on the block. Facebook,
whose founder Mark Zuckerberg is Time's Person of the Year at the
tender age of 26, is apparently valued these days at approximately
$55 billion, based on recent private investments in the company.
Twitter is approaching $4 billion in market cap.

And still another answer is that Apple and Google and others are
under pressure to keep innovating or fall behind.

Speaking of Zuckerberg, my colleague Randall Forsyth observes

that Persons of the Year don't always fare so well. Jeff Bezos
of Amazon.com (AMZN) was picked in 1999, and we know what
happened to tech soon afterward.
 One company that seems perfectly happy to just sell devices,
without planning an "ecosystem," is Research in
Motion (RIMM), maker of the BlackBerry. Last week, it beat
expectations for its fiscal third quarter, ended in November.

But on a conference call with analysts Thursday to discuss the

results, there was a tussle. RIM's management wanted to talk about
its forthcoming tablet computer, the PlayBook, which is meant to
rival the iPad. Analysts wanted to talk about how RIM will tie the
PlayBook and the BlackBerry together with "services" for
consumers–music and movie downloads, social networking, etc.

RIM co-CEO Jim Balsillie's answer—that the company has lots of

partnerships planned—was unconvincing. Currently, the lack of an
ecosystem for RIM isn't hurting its business. Revenue rose 40%,
year over year, and it generated another $675 million in free cash.
But building an ecosystem will be costly; so this issue will haunt
the stock in 2011, unless Balsillie & Co. clearly define their plans.

REASONABLE MINDS CAN ALWAYS disagree. Merrill Lynch

and Citigroup's chief equity strategists each sat down with the
media last week to offer quite different opinions on what will
happen to tech in 2010.

Merrill's David Bianco sees the best risk-to-reward ratio in "big

international growth stocks,"with tech and energy as the most
prominent groups. Tobias Levkovich, Citi's equity maven, is less
sanguine. "Everyone likes tech," he says, "and that's often because
they've already bought it." Of 330 "leading indicators" that Citi's
team crunches regularly, those most correlated to tech point to
underperformance, he tells Barron's.

If there's one thing more contentious than the ecosystem, it's the
prognostisystem.

BlackBerry Message
Oracle and Research in Motion both reported strong November quarter
results. The Nasdaq Composite Index ended the week at 2,643, higher by
0.2%.

STREETWISE
| SATURDAY, DECEMBER 18, 2010

The Seven-Year Switch

By MICHAEL SANTOLI | MORE ARTICLES BY AUTHOR

The year 2004 has served as a useful, if imperfect,

touchstone for investors. Some parallels are eerie,
some mere coincidence. What it means for 2011.
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When it comes to conjuring what the future will hold through 2011,
leave it to an old history major to first recount some relevant
themes of the recent past.

With the stock market tickling new highs as an oft-anxious, largely

range-bound year sets, we still can say, "This year, the stock
market's gains have been capped by sluggish job growth, limited
wage gains and concerns about a slowing economy.

"On the upside, however, stocks were bolstered by corporate-

earnings growth…[well] above what analysts had forecast a year
ago. Due to the one-two punch of low interest rates and heavy
government spending, money flowed freely this year. As always,
much of it found its way into the riskiest investments, some of
which posted the year's best returns."

This was true of the year now ending -- just as it was true in
December 2004, when this recap appeared in Barron's market-
outlook cover article ("A Bullish Toast to 2005," Dec. 13, 2004).

The year 2004 has served as a useful, if imperfect, touchstone here

for at least a year. Some parallels are eerie, some are mere
diverting coincidence. As 2004 opened, the Standard & Poor's 500
index had rallied ferociously off a March bear-market low and sat
at 1112; this year it began at 1115, having surged even further from
its March 2009 bear-market trough.

In '04, it knocked around a narrow path until a late-year rally

carried it above 1200 to 1211. This year the ride was similar, if more
dramatic, rallying into April and then dropping quickly by 17%,
before the late-year rally carried it back above 1200, to a current
1243.

In both years, the consensus entering the year was that Treasury
yields should rise and the market would remain volatile. In both
years, the 10-year Treasury yield, while jumpy, hardly budged from
start to finish, and market volatility plummeted all year, reflecting
the numbing effects of heavy liquidity.

Then, as now, the market was up respectably, yet finished at a

valuation lower than where it started, with corporate earnings
advancing far more than share prices did, even as profit growth
was about to decelerate sharply.
Yes, of course, historical analogies go only so far. Hold the e-mails
inveighing that in '04, Humpty Dumpty was still on the wall, the
credit bubble was still being inflated, that we are now in an
economy detached from precedent.

There's no denying the economic hole this time was much deeper,
the fabric of the financial markets was torn far more violently, and
the observable risks to the global economy today are certainly more
daunting.

Yet markets have rhythms tied to the interplay of psychology and

the business cycle. And while they are only a rough guide for what
to expect, what they aren't is irrelevant. Investors forget that it's
better to have the problems exposed and absorbed than to be
unaware they're there, fuses burning.

The stock market capitalizes not the absolute level of strength in

the domestic economy, nor the mood of the median household, but
rather a private profit stream of mostly large, substantially global
companies. With the S&P 500 at 1200 six years ago, analysts were
looking for $72 in S&P earnings the next year; now, at just above
1200, the consensus is near $95. That still isn't outright cheap,
given the contingency of such forecasts and the world's instability,
but it certainly isn't a challenge to further upside should the world
decline its plentiful invitations to end.

And the psychology on Wall Street now is pretty close to where it

was a few years ago—mostly bullish, with a growing collective
belief that things have turned for the better, after months of mass
frustration over the unsatisfying pace of economic recovery. This is
probably a short-term challenge for further market progress.

As this week's cover story sets out, professional market

handicappers are collectively quite optimistic about the coming
year in stocks, looking on average for handy double-digit gains. In
'04, this club was bullish, but not expecting much more than mid-
single-digit percentage gains.
The weekly American Association of Individual Investors poll has
registered above-average (and lately borderline extreme) levels of
bullish opinion for 15 straight weeks. The last streak of such
duration was -- guess when -- from August to December 2004.

Without prolonging the suspense, the first part of 2005 was flat to
down into April, and then recovered, suffered the scripted autumn
pullback before surging into year end for a modest annual gain,
giving way to what would be a quite strong 2006.

This would fit with history, too, if something like this course played
out next year. Oppenheimer strategist Brian Belski, noting the
growing bullishness among Wall Street strategists, points out that
a third year of double-digit gains -- implicit in the consensus
forecast -- would be an anomaly. Since World War II, there have
been 10 back-to-back double-digit advances. Only twice (1951 and
1994) did the streak run to a third year, and the average return in
the third year was 1.7%.

BACK TO TODAY: After closing eyes and ears to any signs of

possible economic improvement or policy progress for the middle
part of this year, as Europe's debt disease and domestic double-dip
paranoia were paramount in investors' minds since the election,
the standard bullish talking points are on the lips of most market
players.

The Fed is pumping money in, which is good if the economy needs
it and better (for markets) if it doesn't. Profits are poised to keep
growing, the economy has some traction, lower taxes are a boon.
And if one more pundit "informs" us that the year after a midterm
election is "always" positive, and is the strongest year in a
presidential cycle, it might be time for self-defined contrarians to
stage a ceremonial burning of the Stock Trader's Almanac in front
of the New York Stock Exchange.

This cozy consensus is more a short-term tactical risk to the market

than a run-for-help signal, and it ought to be upset by the headlines
or a sudden selloff before too long. This would perhaps puncture
some prevailing optimism and set the next investment theme on
firmer footing.

Against this near-term bullishness remains a heavy and only slowly

thawing aversion to risk among the public, and an abiding demand
for catastrophic financial-risk insurance. This, along with the fact
that the market sits at a level first reached almost 12 years ago,
continues to argue that those with a five-year-plus time horizon
enjoy tailwinds to their returns.

We are at the point in the market cycle where massive profit

recoveries and the reversal of dramatic oversold conditions
following a terrible bear market give way to variations on the
"greater fool" theory of owning something because someone else is
apt to come along and pay more for it.

And so the bullish voices are insisting that nervous stock-avoiders

will react to a firm market, tax goodies and signs of economic
momentum by slowly reallocating toward stocks. Could be, though
this never seems the dramatic swing factor in equity prices that it's
made out to be. Consider that the market is up 83% from its March
'09 low, and most of the time Main Street was pulling money out.

But one form of "greater fool" investing that appears far more
likely to tilt 2011 further to the upside than the baseline case for
moderate gains, after a pullback or sideways stretch, is a
burgeoning revival of financial engineering: leveraged buyouts,
debt-financed buybacks, aggressive growth-seeking mergers and
the like, most all equity-friendly.

This would also represent a re-run of the mid-2000s (and the

mid-'90s, and the mid-'80s, for that matter). One would hope this
action would be carried out with some important lessons learned
and a new-found sobriety. Hope for it, but don't bet that way.