Weekly Buzz: 🔍 Finding a stock is good, finding an industry might be better

01 December 2023

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The big money is not in the buying or selling, but in the waiting.” - Charlie Munger 🙏🏽

Spotting good companies is great, but spotting industries with long-term potential might be even better. After all, if an industry is growing, companies operating there stand to benefit, and you’ll be diversifying your exposures across all of them. As they say, a rising tide lifts all boats.

Here are four traits to keep an eye out for when searching for industries with long-term potential.

1. Resilient growth

When a company can generate strong cash flows, it can fund its own growth – an increasingly important consideration when interest rates are high. Look for industries with resilient growth or recurring revenues. Sure, 5% annual growth might not seem as sexy as 15%, but an industry that can sustainably grow at 5% on average over the long term, even through recessions, should grab your attention.

2. Economies of scale

The bigger you grow, the cheaper your growth is. In short, that’s what economies of scale means. After spending some initial money on growth, a company can leverage on that to drive the next leg of growth – for cheap. This also means profitability can grow faster than sales.

These companies tend to have higher fixed costs, but lower variable costs. An online education platform might have to spend a certain amount to employ engineers and analysts to serve one customer on its app – but it can also serve more customers with that same, initial investment. The more customers it has, the lower the average cost per customer.

3. High value, low cost

Great industries turn out products that have a high value but a relatively low manufacturing cost. Take for example, your favourite perfume. You love the scent; its distinct woody undertone you can’t get elsewhere. But the ingredients that gave it its fragrance were likely only a fraction of the total product cost. And yet, that probably had a large influence on your purchasing decision. Products like these have a low cost to value ratio, commanding high pricing power.

4. High barriers to entry

Industries that have strong barriers to entry (our Jargon Buster below breaks this down) prevent new rivals from grabbing market share, maintaining their profitability. Take a look at the luxury industry, for example; high brand loyalty here serves as a deterrent to new competition, and allows established companies to continue growing with high margins.

What’s the takeaway here?

Thinking of long-term investing through the lens of industries, instead of individual stocks, can be a strong investment strategy.

But while these are great traits to watch out for, markets can change, and these traits can vary in importance. For example, when interest rates were far lower over the past decade, borrowing money was cheap, and companies could chase growth even at lower returns. That’s changed in our current environment.

If you’re interested in tailoring your investment exposure to one or more industries, consider using our Flexible Portfolios. These allow you to select from a wide range of ETFs, capturing growth in specific industries, like fintech or pharmaceuticals.

📰 In Other News

The price of gold closes in on a 6-month high

Gold’s a go-to place to stash cash when the wider environment turns uncertain, because it tends to hold its value throughout inflation, global turmoil, and currency dips. See, gold doesn’t dish out income like stocks and bonds, so when high interest rates make income-producing assets look more rewarding, the metal tends to get the cold shoulder.

But the opposite is true when rates are lower, and now that Wall Street’s whispering about interest rate cuts, investors are buying up gold in anticipation of a turnaround. The result: the price of gold has crept above the $2,000 mark, now approaching the record $2,075 from 2020.

Despite inflation showing signs of defeat and the economy staying strong so far, the risk of seeing the opposite – sticky inflation and sluggish economic growth – is still looming. That could make it tough for traditional assets like stocks and bonds. And that’s the type of environment when you might consider hardy gold in your portfolio.

This article was written in collaboration with Finimize.

🎓 Jargon Buster

Barrier to entry

A barrier to entry is just that – some hurdle that makes it tough for new companies to break into a market or industry. For example, needing a lot of cash to start up (like in manufacturing), having to deal with strict regulations (like in pharmaceuticals), or even having to overcome existing brand loyalty (like with luxury goods).  High barriers to entry mean less competition for those already in the game, which can lead to a more secure market position and higher profits.

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