The current extended bull market is both exciting and scary.

 

#-ad_banner-#The higher the market goes, the more nervous investors become about the risk of a crash. Such skittishness sometimes prompts dramatic overreactions to relatively minor performance issues — even with the best companies. Astute long-term investors love when this happens because it can create brief opportunities to buy great stocks at more attractive valuations.

 

The well-known metal parts and castings fabricator Precision Castparts Corp. (NYSE: PCP) is a perfect example of this.

 

Precision Castparts is a global market leader that has been around for more than six decades. During that time, it evolved from a tiny provider of chain saw cutters to a diversified giant worth $32 billion. The company now makes specialized metal castings, parts, forgings and fasteners for multiple industries including aerospace, energy, healthcare and defense.

 

The company has a superb long-term track record. Annual revenues have risen nearly 13% a year since 2006, from $3.6 billion to a projected $10.3 billion in fiscal (March) 2015. During the same period, earnings per share raised at a 21% pace, to an expected $13.50 a share in fiscal 2015.  The gross, operating and net margins are all at decade highs, as is free cash flow.

 

Yet shares of Precision Castparts are down about 15% over the trailing twelve months, compared with more than a 10% gain for the S&P 500.

 

So what gives? Wall Street appears to be overreacting to small earnings misses in three of the past four quarters.

	13-Dec	14-Mar	14-Jun	14-Sep
EPS Estimated	$3.04	$3.20	$3.35	$3.32
EPS Actual	$2.95	$3.27	$3.32	$3.24
Difference	$-0.09	$0.07	-$0.03	$-0.08
Surprise %	-3.0%	2.2%	-0.9%	-2.4%

Note: Fiscal year ends in March. Data shown are for Q3 and Q4 of fiscal 2014 and for Q1 and Q2 of fiscal 2015

While any cluster of earnings misses could be a red flag, I am not overly concerned in this case. Precision Castparts can have the occasional bout of hiccups because of customer-related factors, such as last-minute decisions to push back delivery dates in response to changing production schedules.

 

It’s the sort of thing the firm has faced more often in recent quarters. In the third quarter of fiscal 2014, for example, the bottom line lagged expectations by 3%. The quarter was marked by some unprecedented dynamics, said CEO Mark Donegan, with customers significantly shifting delivery schedules very late in the quarter — too late to prevent the changes from dragging down the bottom line.

 

While this unfortunate run of bad luck should be relatively brief, it may not quite be over. When discussing company performance for the latest quarter, Q2 of fiscal 2015, Donegan cautioned that some customers asked that late-December deliveries be postponed until January as a year-end cost-management strategy. So there’s a chance Precision Castparts could disappoint in the current quarter, too.

 

If that happens, then shares may come under renewed pressure, though this would simply boost the value proposition for this stock.  

 

Precision Castparts is poised for years of further double-digit growth largely because of rapid expansion of its aerospace business, which is seeing steady demand for airframe and engine components in developed and emerging markets. Aerospace products now account for 68% of sales, compared with about 60% a few years ago.

 

As key commercial aircraft programs at major aerospace firms, like Airbus Group N.V. (OTC: EADSY) and The Boeing Company (NYSE: BA), start to ramp up, PCP should feel a direct top-line boost.

 

The company’s relationship with Airbus is a fairly new development, thanks to a $625 million acquisition of Aerospace Dynamics International (ADI) in March 2014, which was already a key supplier to the Airbus A350. That plane should draw a significant portion of the $1.9 trillion in wide-body sales projected for the next two decades.

 

The ADI deal, which is expected to close in the first quarter of 2015, also provides some much-needed diversification. Prior to the ADI purchase, Precision Castparts was mainly exposed to the commercial aircraft market through Boeing, most recently by providing millions of dollars in landing gear fasteners, engine parts and other components for every 787 Dreamliner — Boeing’s newest wide-body passenger jet.

 

The heavy reliance on Boeing became a concern in early 2013, when the FAA temporarily grounded the entire 787 fleet for battery problems, which had resulted in some emergency landings. Fortunately, the battery glitch was resolved and Precision Castparts emerged relatively unscathed. But the damage might have been substantially worse if the 787 had more serious issues leading to long production delays. Having two major wide-body customers will better shield Precision Castparts from such risks.

 

So will a strong presence in two unrelated areas — the power and industrial markets, which generate 18% and 14% of sales, respectively. On the power side, management expects particularly strong demand for gas turbines for use in power plant construction and retrofits.

 

The $2.9-billion acquisition of Titanium Metals Corporation (aka Timet) in November 2012  filled a significant void in the industrial business by adding a unique line of high-performance titanium parts for factory equipment. In fiscal 2014, industrial product sales grew 10% to nearly $1.4 billion, mainly because of the addition of Timet, management says.

 

Considering the strength of Precision Castparts’ end markets and how quickly the firm has increased earnings in recent years, consensus estimates for growth of 13% annually seem conservative. Still, even that pace would push per-share profits up to $23.60 in five years. At the current earnings multiple of 19, this suggests the potential for a roughly 90% stock price gain during that time, to around $448.

 

Risks To Consider: Precision Castparts operates in highly cyclical end markets where customers regularly demand price concessions and promote competition among suppliers.

 

Action To Take –> Investors seeking superior capital gains should consider establishing or adding to a long position in Precision Castparts. With a yield of just 0.1%, the stock isn’t appropriate for income investors.

 

StreetAuthority is proud to present its newest research report “The Top 10 Stocks For 2015.” Since we first began publishing this annual research report in 2003, our picks have beaten the overall market eight out of 12 years, including years with average gains of 37%… 38%… and 39%. For comparison, the S&P 500 gained more than 30% in just one year since 2003. To learn more about this list of elite companies, click here.