This article is a reprint of my February 13, 2008 RealMoney column.

Late last year I used the government’s PPI data by industry to scout out 26 investment ideas, among which were industrial valve manufacturers Flowserve (FLS), Crane (CR) and Curtiss-Wright (CW - Annual Report). In October, I said Flowserve may be the best way to play the PPI report.

Since that column in October, Flowserve has gained more than 22.5%, while the S&P lost nearly 12%. Now the question is whether to let this winner ride or to take the money and run. For now, I think the answer is to keep on going with the Flowserve.

For one thing, they call them “industrial” valves for a reason – and that means there is likely limited exposure to a consumer slowdown. According to the most recent 10K, the company’s customer mix by end market is approximately 43% oil and gas, 23% general industrial, 15% chemical, 13% power generation and 6% water treatment. These are industries with long-term planning needs, many of which are finding themselves behind the curve. I don’t see them slowing their spending any time soon.

This is supported by the pricing power the industry continues to enjoy. Although off the 2007 peak in the double digits, the year/year change in January was still far above the industry’s long-term average and still indicating an overall rising trend.

12-month Percent Change in Industrial Valve Manufacturing Prices

Source: Bureau of Labor Statistics

The pricing power is also flowing through to earnings. Flowserve is set to announce earnings on February 27, but they preannounced in a big positive way at the end of January, which explains most of the stock’s run. Curtiss Wright shares, meanwhile, gained 7% on Tuesday when their earnings beat estimates by $0.09 per share “led by our Flow Control and Metal Treatment segments, which experienced strong organic growth of 23% and 15%, respectively, over the prior year periods.” Crane also walloped estimates when it reported last month.

All these positive estimate revisions caused Flowserve’s Zacks rank to jump up to 1, putting the company among the top 5% of all companies measured in terms of earnings momentum. According to Dan Fitzpatrick, as of last Friday the technicals supported a buy (with appropriate risk controls.)

As with most stock ideas, Flowserve has some downside risk – particularly with regard to valuation levels. In particular, its 1.8% free cash flow yield is below the yield on Treasuries – meaning that a good deal of the return must come from growth. There are several names that offer similar growth and higher free cash flow yields, particularly among the software companies I look at. Still, I think there could be benefit to owning Flowserve for diversification purposes.

Its 19x forward P/E ratio isn’t among the cheapest available, and is toward the high end of the 8x – 24x range at which Flowserve has traded over the last five years. Its price/book ratio is also significantly higher than those of its peers. I would not be at all surprised to see the valuation contract in the short term, and I am virtually certain it will contract in the longer term.

But taking the valuation ratios down to the five year average over the next five years would knock about 4-5% per year off the return, by my estimates. Given the 20% annual expected growth rate over that period, that still leaves room for annual returns of 15% or so, which I think will far outpace the S&P 500 over that time.

Disclosures: None

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Last month I showed how investors can generate investment ideas by using the Producer Price Index (PPI) report prepared monthly by the Bureau of Labor Statistics. The idea is that industries where prices are rising may contain companies where revenue will grow faster and/or margins will improve.

Of course, like any initial screen the PPI report is only a starting place. It is useful to generate ideas, but further research is needed to determine whether they are good ideas. This month, I do some of that further research.

One industry where the price increases have been flowing is industrial valves. Although the increases have been flattening out somewhat, the 8.3% year/year gain in September is still pretty sweet.

As I mentioned last month, some of the industrial valve makers include Flowserve (FLS), Crane (CR) and Curtiss Wright (CW - Annual Report). Let’s see how they are doing.

According to Flowserve, the PPI indicator is right on the money. Flowserve noted in its latest earnings report that its Flow Control Division’s “gross margin of 35.6% for the second quarter of 2007 was substantially higher than the second quarter of 2006, up 140 basis points. This increase was principally due to improved absorption on higher sales, the implementation of various Continuous Improvement Programs and cost reduction initiatives and improved pricing.” With sales up 13%, bookings up 15%, and pricing remaining strong it looks like the trends could continue for some time.

Crane is also doing well. Crane’s Fluid Handling segment saw a 13% gain in sales and a 30% increase in backlog in the latest quarter. However, “Margins remained at 12% reflecting more price competitive project work and investments in new products and systems to support future growth.” That “price competition” isn’t doing any damage yet, but it could. It may be especially important to watch the PPI reports on a continuing basis to find the right time to get out of a position before the eventual loss of pricing power is picked up in an earnings report three months later.

For Curtiss Wright’s Flow Control division, “Sales for the second quarter of 2007 were $163.2 million, up 26% over the comparable period last year due to solid organic growth and the contribution from the 2006 and 2007 acquisitions. Sales from the base businesses increased 14% in the second quarter of 2007 as compared to the prior year period.” Profitability declined primarily due to cost overruns on a Navy project, but the company noted that margins were also impacted by “labor inefficiencies, business consolidation costs, and higher material costs experienced within our oil and gas market.” The stock has rallied on strong results and increased guidance from its other divisions, however.

After taking a closer look at the three valve makers, I think Flowserve may be the best way to play the PPI report. For one thing, valves and related products make up a larger part of its revenue. As a purer play, the pricing information conveyed from valve PPI is more relevant. It’s true that the better performance has not gone unnoticed by the stock market, which has boosted FLS shares more than those of CW or CR in the last couple of years. However, based on the continued strong pricing environment it looks like that strong performance could be sustained.

Originally published at RealMoney on September 19, 2007.

Tony Crescenzi says the latest PPI report should be tossed because the benign headline reading will almost certainly be reversed in the months ahead owing to the surge in energy costs that has occurred of late. I say not so fast! If prices are rising, that means some companies out there are likely to see better profits. Before tossing out the report, I’m betting we can figure out who a few of them will be.

The Bureau of Labor Statistics, which prepares the PPI report, provides detailed information on an industry basis. The problem is figuring out how to find it on their web site. Starting at the PPI home page, I scroll down to the headline that says “Get Detailed PPI Statistics” then click on Industry Data. You can then pick out which industries you want to see (I pick ‘em all) and click “Retrieve Data.” Then I select “More Formatting Options” and click on the boxes for 12-month percent change, all years, and include graphs. Once I hit “retrieve data” again I have what I’m looking for - graphs that make it easy to tell which industries are gaining or losing their pricing power.

First up is the fruit and vegetable canning industry. At 5.3% year/year inflation, pricing is clearly better than normal. It is down from a recent peak but still looks to be generally in a rising trend.

Possible plays on this industry include can makers such as Ball Corp. (BLL), Crown Holdings CCK - Annual Report), or Silgan (SLGN - Annual Report). Or you can go to the food processors such as Campbell Soup (CPB), Del Monte (DLM - Annual Report), Hain Celestial (HAIN), or HJ Heinz (HNZ).

Looking better still are industrial valves, up 9.3% year/year against tough comparisons.

Some of the industrial valve makers include Flowserve (FLS), Crane (CR) and Curtiss Wright (CW - Annual Report).

But enough with boring “old” industries. How about tech? It is seldom that tech prices actually increase, but sometimes they decline at a slower than usual pace, which can provide a similar opportunity. That may be the case right now with computer storage devices.

Last month’s 2.9% decline from last year was the smallest price drop on record for this industry, and the ongoing consolidation may help the trend continue. Plenty of ways to play this one, including Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), Sandisk (SNDK - Annual Report), Seagate (STX - Annual Report), and Western Digital (WDC).

By contrast, semiconductors are experiencing the worst pricing on record.

That could be the signal for a contrarian play (I happen to think the worst will soon be over for semiconductors) or possibly just an excuse to avoid the group for a while.

The PPI clued me in to the opportunity in railroads a year before Buffett bought in. I hestitate to bet against him, but it looks like the industry’s price increases have ground to a halt.

If you have the guts, I’d count this as bad news for Burlington Northern (BNI), CSX Corp. (CSX), Norfolk Southern (NSC), and Union Pacific (UNP).

Finally, Wired Telecommunications saw pricing decline for years after the 1996 Telecom Act, but recent consolidation is allowing them to raise prices again.

Winners here would be CenturyTel (CTL), AT&T (T - Annual Report), Verizon (VZ - Annual Report) and Embarq (EQ).

By my count, that is 26 potential stock tips, all courtesy of the U.S. government. I’ll take that over tossing the report any day.

Disclosure: Long Semiconductor HOLDRs (SMH).