THE STANLEY WORKS $51 (New York symbol SWK; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 82.2 million; Market cap: $4.2 billion; WSSF Rating: Average) makes a wide variety of hand and power tools for consumers and industrial users.

In addition to the Stanley brand, the company’s best-known trademarks include Bostitch, Husky, Monarch, and Mac Tools. It sells its products through home improvement chains such as Home Depot and Lowe’s, and independent distributors.

In the past few years, Stanley has spent $2 billion on acquisitions to shift its focus from consumer products to industrial products and building security systems, which have steadier revenue streams.

Thanks to these acquisitions, Stanley’s revenue rose from $2.6 billion in 2002 to $4.0 billion in 2006. Profits fell from $2.31 a share (total $203.9 million) in 2002 to $1.90 a share ($161.6 million) in 2003. Earnings rose steadily to $3.47 a share ($290.7 million) in 2006.

Stanley’s biggest purchase to date was its $544 million acquisition of HSM Electronic Protection Services Inc. in January 2007. HSM designs and installs building surveillance systems that guard against intruders, fire and other threats.

This business has annual revenue of around $200 million, and should increase Stanley’s annual per-share earnings by $0.20 to $0.25 by 2009.

Security focus cuts risk

Stanley already makes security hardware such as locks and automatic doors, so HSM looks like a good fit. HSM also provides its customers with 24-hour monitoring services, which gives Stanley recurring revenues, and cuts its reliance on hardware sales.

Security products and services now account for a third of Stanley’s total revenue, compared with just 10% five years earlier.

The company is also expanding its industrial tool operations, which specialize in tools for carmakers and other manufacturing companies. High-end products like these generate bigger profits for Stanley than tools for consumers.

The company’s 2006 purchase of French industrial toolmaker Facom also expanded its international operations to nearly 50% of its total revenue.

New products help drive sales

To spur tool sales, Stanley has launched several successful new products in the past few years. For example, its FatMax line of professional hand tools feature large, ergonomically designed grips that resist slipping. That makes them easier to use, and cuts the risk of accidents.

The company has also developed a new type of nail that can help buildings better withstand hurricane force winds of up to 170 miles per hour, earthquakes and other natural disasters.

Stanley is spending more on advertising to improve awareness of its famous brand. The company has a long history of making high-quality products, and this helps it compete with cheaper imported tools.

The company is also expanding its overseas operations. It now has over 300 outlets in China, and has increased its product line from 50 to 550 items. In India, Stanley has formed alliances with local toolmakers and distributors to expand the availability of its products.

Gaining from Asian construction boom

These moves will help Stanley profit from increasing construction activity in both countries. Rising car sales in China and India should also increase demand for tools by auto mechanics.

Stanley continues to cut costs. In the past three years, it has recorded $27.8 million in restructuring charges. But these moves will help Stanley cope with rising steel and fuel costs.

Stanley’s aggressive expansion has increased its long-term debt by 77%, from $679.2 million since the end of 2006 to $1.2 billion. But it’s still reasonable at 30% of Stanley’s market cap.

The company generated cash flow of $380.6 million or $4.51 a share in the nine months ended September 30, 2007, which will help it pay down the extra debt.

Plenty of cash for share buybacks

Stanley is also using its growing cash flow to buy back stock. It spent $106.9 million on share buybacks in the first nine months of 2007. That helps Stanley offset shares issued under its employee stock option plan.

The stock has moved down lately on fears that the problems in the home mortgage market will continue to slow new home construction and renovation activity. But Stanley’s growing industrial and security businesses cuts its exposure to the U.S. housing market.

Stanley’s shares now trade at just 12.8 times the $4.00 a share it should earn in 2007. The stock is also cheap at 8.4 times its forecast cash flow of $6.05 a share, and at 98% of sales of $52 a share.

Dividend hikes should continue

The company has raised its dividend for 40 consecutive years. The current annual rate of $1.24 a share yields 2.4%.

Stanley Works is a buy.