Is Eaton Stock a Buy Now?

Eaton (NYSE: ETN) is one of the world's largest industrial companies. While it isn't on the top-10 list for that sector, its $131 billion market cap is just shy of Union Pacific's (NYSE: UNP) $136 billion. One of the most interesting features of Eaton's business is how it has evolved over its more than 100-year history. And it is about to do it again, if the rumors are true.

Given the rumors, is Eaton stock a buy now?

A brief history of Eaton

Eaton began its corporate life making truck transmissions. Transmissions are, effectively, a method of controlling a vehicle's power. Over the years, it added and subtracted business lines but took on a focus on power management. The biggest change for the company came when it agreed to acquire Cooper Industries in 2012. The nearly $12 billion transaction was the largest in Eaton's history.

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Cooper's integration provided greater exposure to electrical products. That was just the first move. Eaton has continued to make acquisitions and dispositions to further fine-tune its business portfolio. For example, it sold its highly cyclical hydraulics business, in which key end markets like construction products experienced large boom-and-bust cycles. Today, this industrial giant generates roughly 75% of its revenue from electrical products.

With growing demand for electricity from things like AI, data centers, and electric vehicles, Eaton's pivot toward electrical products looks prescient. Wall Street has noticed, with the stock up around 600% over the past decade. That's more than twice the roughly 270% gain achieved by the S&P 500 over that span.

Is more change on the horizon?

The interesting thing about the electrical products business is that it is less cyclical than the company's historical operations. So Eaton is a more reliable business today than it was a decade ago. However, some business lines remain volatile, such as the company's legacy auto business.

There are rumors that Eaton is considering selling or spinning off that business. Some estimates suggest the auto division could be worth as much as $5 billion if it were sold. This move would further tie Eaton's future to electrical products, likely lead to lower leverage, and could give it additional capacity for bolt-on acquisitions in the electrical products space. From a big-picture perspective, it sounds like a good plan.

There's just one problem if you are considering buying the stock. Eaton's price-to-sales ratio of 5 is above its five-year average of 3.9. The company's price-to-earnings ratio of 33 is above the five-year average of 32. And the price-to-book value ratio of 7 is above its five-year average of 4.7. The stock's 1.2% dividend yield is near the low end of its historical range. All in, Eaton stock looks expensive.

Most investors should keep Eaton on the watch list

If you own Eaton stock, there is no reason to sell it. In fact, selling or spinning off the auto division could further improve the business. Even with that potentially good news, the stock is still trading at a premium. If you factor valuation into your stock purchase decisions, Eaton probably won't be of interest. You'd likely be happier waiting for a bear market before revising Eaton.

And while growth investors might be excited by the potential business overhaul, the 33 P/E ratio is already well above the 28 of the S&P 500 index. It seems like it would be better to hold off on buying the rumor and watch to see if this news actually unfolds. Even then, you might want to see if the results of the potential business overhaul turn out to be as good as they sound before investing.

Reuben Gregg Brewer has positions in Eaton Plc. The Motley Fool recommends Union Pacific. The Motley Fool has a disclosure policy.