5 Stocks From the New Class of Rising Blue Chips

When you think of blue-chip stocks, big brand-name companies such as Coca-Cola (symbol KO), McDonalds (MCD) and Johnson & Johnson (JNJ) come to mind. But John Fox, co-manager of the FAM Value Fund (FAMVX) and director of research at Fenimore Asset Management, the fund’s sponsor, unearths what he calls “rising blue chips” -- midsize companies that dominate their industries and have a global reach. “They’re smaller than IBM and Proctor & Gamble, but they’re blue chips in a lot of ways,” Fox says.

These midsize dynamos share other characteristics with the best blue chips: a proven business, exceptional free cash flow (earnings and depreciation, minus capital expenditures) and skilled managers who use their company’s capital to enrich shareholders.

Below are five Fox favorites worth watching. He holds all of them in FAM Value, but he is not adding to his positions at current prices. They’re quality companies, but he’d buy on pullbacks.

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Donaldson (DCI)

Market capitalization: $5.5 billion

Percentage of sales from outside the U.S.: 60%

When it comes to air filters, the trucking industry turns to Donaldson. The Minneapolis-based company makes air filters primarily for trucks and industrial equipment, such as tractors and bulldozers, for big-name customers such as Caterpillar (CAT) and Deere (DE). The filters, which reduce the pollution released by these vehicles, are also used in mining equipment and gas turbines. And Donaldson has a lock on this business, which produces a steady stream of income because filters wear out and need to be replaced regularly.

International expansion is likely to drive Donaldson’s growth in the future. The company is building a new manufacturing plant in Mexico, which will help it meet strong demand in Latin America, and it has a number of gas-turbine projects under way in the Middle East and China, not to mention the U.S.

Donaldson’s earnings increased at a nearly 12% annualized clip over the past five years. They are projected to rise nearly 13% per year over the next three to five years, thanks to strong demand for trucks (many of which use Donaldson filters) in emerging markets. At $36.70, Donaldson trades for almost 20 times estimated earnings of $1.88 per share for the next 12 months. (Share prices and related data are as of the May 29 close.)

McCormick (MKC)

Market capitalization: $7.6 billion

Percentage of sales from outside the U.S.: 40%

Open your cabinet and check out the brand name on your spice jars. Chances are good they say McCormick. The Sparks, Md., company controls the largest share of the market for spices and food flavorings, and with anticipated earnings growth of 9% annually, its shares make a tasty investment. For busy families, McCormick sells recipes coupled with spices pre-mixed in the right quantities. All you have to do is buy the meat, mix in the spices and cook.

Meanwhile the company’s recent acquisition of a Polish mustard company and a joint-venture with a rice company in India should keep sales growing at a nice clip. At $57.46, the stock trades at 19 times estimated earnings of $3.05 per share for the year that ends this November. McCormick also pays a $1.24 per share annual dividend, up 51% from five years ago. The stock yields 2.2%.

Sigma-Aldrich (SIAL)

Market capitalization: $8.8 billion

Percentage of sales from outside the U.S.: 67%

With more than 176,000 products and next-day delivery anywhere in the world, Sigma-Aldrich is the premier go-to chemical company for the drug and technology industries. Its chemicals are used in biotechnology and pharmaceutical development, diagnosis of diseases and high-tech manufacturing. Sigma recently bought biologic-testing company BioReliance, which serves about 90% of top biotech firms and 75% of leading pharma companies, in a deal that’s supposed to boost earnings immediately, to the tune of about 5 cents per share this year.

The St. Louis company sports a strong balance sheet. Earnings are expected to grow at a rate of 9% annualized over the next three to five years. At $72.38, the shares trade at 18 times estimated 2012 earnings of $4.01 per share.

Waters (WAT)

Market capitalization: $7.5 billion

Percentage of sales from outside the U.S.: 70%

Waters makes scientific instruments that are used in food-safety analysis and pharmaceutical research, including clinical trials. Waters, based in Milford, Mass., has $1.3 billion in cash and just $700 million in debt on its balance sheet. The company has been using its cash to buy back stock and has reduced the number of shares outstanding by nearly 12% over the past five years.

When it comes to turning sales into profits, few research companies do it better. For every dollar of sales the company generates, it brings about 23 cents to the bottom line. Analysts expect earnings to grow at an annualized clip of 12% for the next three to five years. At $83.36, the stock trades at 16 times estimated 2012 earnings of $5.11 per share.

Xilinx (XLNX)

Market capitalization: $8.6 billion

Percentage of sales from outside the U.S.: 67%

Xilinx makes programmable semiconductor chips that can be customized for new products. That saves inventors of everything from phones to tablets the time and expense of designing a special chip for a newly launched gizmo until they have the sales volume to know it will fly. Xilinx and rival Altera control more than 70% of the programmable chip market. What’s more, Xilinx is a cash machine, generating more than $500 million in cash annually. That has helped the San Jose, Cal., company build a $2 billion cash hoard (it has $900 million in outstanding debt).

At $32.37, shares of Xilinx trade at 17 times estimated earnings of $2.01 per share for the year that ends next March. The cherry on top: Xilinx sports a 2.7% dividend yield -- unusually high for a technology company.

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