Get 90% Upside With This Side Play To The Auto Industry Rebound

At the height of his fame, one of history's top investors, Peter Lynch, regularly marveled at how often one good stock could lead to another in the same industry. And that's just what happened to me recently while reading up on one of my own holdings, Toyota (NYSE: TM ) .

#-ad_banner-#This other "automobile stock" isn't a household name like Toyota, but maybe it should be. It's up about 135% in the past 12 months. And it still has plenty of attractive upside left to offer.

One reason I believe this: The company has very robust sales, which have been climbing more than 10% a year, from $2.9 billion in 2009 to $4.3 billion last year. Also, the firm's earnings per share ( EPS ) growth has been rallying strongly since the nasty $7.19-a-share loss of 2009, when the recession was really raging.

Now that the auto industry is on a roll again, consensus estimates are for EPS to rise 24% a year to $6.63 in 2019 from the current $2.26. However, this "auto stock" could earn $1,000 a share and still never threaten Toyota's position as the world's #1 automaker.

Indeed, the company hasn't sold one car in its 35-year existence. That's because it doesn't make cars.

But I still consider it an auto stock. How can I not when it generates three-quarters of its revenue from automakers?

You might be familiar with this company's products if you own a Toyota. Many other major automakers buy from this company, too, including General Motors (NYSE: GM ) , Daimler ( DDAIF ) , Porsche ( POAHY ) , Volkswagen ( VLKAY ) , Tata Motors (NYSE: TTM ) , Harley-Davidson (NYSE: HOG ) and Hyundai ( HYMLF ) , among many others.

I'm referring to Harman International Industries (NYSE: HAR ) , a leading provider of integrated "infotainment" systems to the auto industry. These systems include things like audio, video, wireless communication, navigation and Internet access. The company also makes some of the more basic electronics typically found in vehicles, such as lighting and climate control.

Harman owns a variety of brands including Becker, JBL, Infinity, Harman Kardon, AKG Acoustics, Mark Levinson and others. If a lot of these sound familiar, it's probably not only because they're in many popular car models but because they're associated with other Harman products outside the auto industry. These products, which account for a quarter of annual sales, include things like consumer and professional sound systems, guitar accessories, microphones and headphones.

YouTube/HarmanIntlHarman International Industries is a leading provider of integrated "infotainment" systems to the auto industry, which include things like audio, video, wireless communication, navigation and Internet access.

As I said, though, I consider Harman an automotive company because that's mainly where its fortunes lie. In fact, the firm has carved out a crucial role in the auto manufacturing process, since its customers must design Harman's products into their vehicles. This greatly helps in maintaining customer loyalty because switching infotainment providers can be difficult, especially once products have been designed in and manufacturing is underway.

Demand for Harman's existing lineup is likely to remain brisk as the auto industry recovery continues, especially since the company typically has long-term contracts with its customers. There should be substantial growth opportunities with some newer auto-related products, too. (My colleague David Sterman examined Harman's place in the coming automobile technology revolution earlier this month.)

For example, early last month Harman introduced VoiceLogic, a speech processor that improves voice quality in automobiles and other noisy environments. The technology can obviously be applied to hands-free communication devices in cars.

Also last month, Harman launched its Signal Doctor software, to be incorporated into all new Harman-branded automotive audio systems. As the name suggests, Signal Doctor restores the sound quality of music compressed into an MP3 or streaming file format. Compression can result in the loss of up to 90% of audio quality.

Although I expect Harman will keep focusing mainly on the auto industry, it won't neglect its non-auto-related business. One of its latest products in this area is the Lexicon MC-14 Surround Processor also introduced in early January. This technology is an upgrade of the MC-12 platform, and it's designed to permit high-quality audio and video in high-end home theaters and home entertainment systems.

Risks to Consider: Because of its recent run-up, HAR trades at a hefty premium, as indicated by a price-to-earnings (P/E) ratio of 46. At such a high valuation, the risk of a sharp price pullback is elevated. As always, Harman must stay ahead of product trends or risk obsolescence.

Action to Take --> Despite the high P/E, HAR is well worth considering. Based on EPS growth projections, the stock could climb more than 90% during the next five years -- and that's assuming a much lower P/E of 30, which compares favorably to its forward P/E of just over 19. At the very least, I recommend investors keep it on their watch lists and wait for a lower entry point. However, the stock has considerable upside even for those who choose to buy at the current price of around $103 a share. (Those who buy now can pick up a slim 1.1% dividend yield for their trouble.)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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