Choosing the right industry
- Oct 20, 2018
- 4 min read
In a world where ideas can roam free, and innovation is the natural order of things, no two business can be similar. And thus, no two business can offer the same value from an investment perspective. But there are forces that even the most disparate and disjoint of businesses cannot escape from. Sometimes these forces can lead to an overall level of benefit for all businesses, and at other times it can spell disaster for the same set of businesses. It thus becomes imperative to know what these forces are, and how we can classify all sorts of businesses into different silos, so that we have a better chance to be in control of our investments and their expected returns.
Today, I am going to help you with exactly that. Let’s see what the guiding principles are about choosing the sectors/industries to invest in.
1. Information availability: “Data! Data! Data! I cannot make bricks with clay Watson.” Sherlock Holmes has decreed it. Who are we to negate it. The foremost aspect in choosing an industry is the ease with which information can be availed. Without easy access to authentic information, you will have absolutely no clue as to where your investments might be heading in the near future. To illustrate the point, assume that you want to invest in a music production company. If you have no idea about the fact that albums are dead, there are lot of freelance music composers, and the taste for music has been changing drastically over the last decade, you might just find yourself investing in a big name company, which has the majority of its revenue from selling albums. And pretty soon, the company will go bust, and your investment will go kaput! Usually some industries are more regulated than the other (for example steel). Such sectors have to produce publicly available information. This makes it easier for an individual investor to assess the attractiveness of an industry. Some of the other industries are usually have no such obligation, which makes public data on them far more scarce. These sectors are usually covered by the equity research companies, and they sell these reports at exorbitant prices, considering the wallet size of an average individual investor. The best way to circumvent this mistake, and its associated frustration, is to go to Google and make an ordinary query about the industry. If the industry is well covered, you’ll find tons of data on the performance and prospects of the industry, both government and private documentation.
2. Understanding the industry: When you put your money to work for you, it is always better to know where your money is heading to toil. Having a lot of easily available information is not going to reap benefits, unless you consume the information, make sense of it, and them put it to good use. Always read about the industry, the products, the prices, the customers and the potential market size. Then read about the manufacturing/ service processes involved, and see if you can understand the flow of the cash in these processes. For example, you should be able to understand how cash and coal are related in the cement industry. Once you have a decent grasp of the processes involved, you can easily fathom the impact of any subsequent information that comes to you. It is at these junctures that you will be able to time your entries and exits, profitably. In today’s world, there are tons of videos and articles freely available that explain the industrial processes in depth. Look for such sources and see if you can get a hang of these processes. Do note, that everyone may not understand everything. So there is no shame in admitting to yourself that you do not get the hang of some industry. In such situations, it is best to skip that industry from your portfolio. Known evil is better than unknown ones!
3. Company before Industry: Now this is not a guideline. It is a large red warning! Most individual investors only look at the bright and shiny present performance of companies to make investment decisions. They convince themselves that the sector looks bright because their desired company is enjoying a flood of cash inflows and profits. And that is where you kill your investment in the cradle.
Never analyse a company before analyzing the prospects of the industry! The most common example for this will probably come from the airlines industry. Remember, it is your hard earned money. Treat them with rationality, and not frivolous speculations. The general rule is to read about 5-7 industries, of which most mortal beings will be able to make sense of 3, when they are just starting out. Then you look at individual companies. And then finally you arrive at your portfolio. With time you’ll learn more about the processes involved in analyzing other industries. And slowing but surely, you will build a long standing, dividend generating and well-diversified portfolio of investments.
And that’s all about the basic tenets of choosing industries.
If you have enjoyed this article, consider subscribing to our page, and our YouTube channel.
Let’s learn investing, together. Happy investing!
Comments