Should You Invest In Great Companies Or Just A Great Industry?

invest-great-companiesIt’s not a coincidence that companies within a certain industry tend to rise and fall together. There are many consumer and competitive forces in play that can affect similar companies. These same forces also affect the success-fulness of the industry in general.

All industries tend to follow the same patterns over time. Understanding these patterns can give smart investors a much better understanding of their investments.

In researching a possible investment, keep these points in mind:

1. Emerging and high-growth industries are high-risk investments. Even a single company can start an entire industry. For example, Alexander Bell single-handedly started the telephone industry.

* Companies that are establishing themselves in emerging markets are risky investments. Many are primarily concerned with raising cash and performing research and development (R&D). These companies can take years to start actually selling a product and receiving income.

* In many cases, the market place has not yet accepted the products offered by these companies. Companies in emerging markets are not for the faint of heart. There is significant risk, though the rewards can be spectacular.

2. Rapid growth industries have rapidly increasing sales and earnings compared to other industries. These companies should have above average earnings for a couple of years. The future should also look exceptionally bright for these firms with regards to sales and earnings.

* Another way to spot these industries is by the lower prices. Competitive pressure and economies of scale become significant factors. It’s simply less expensive per unit to make 100,000 of something than it is to make 10.

* The home computer industry is a great example of a rapid growth industry. A great deal of money was spent on R&D, and products were initially very expensive. In time, competition developed and prices dropped dramatically, primarily due to the large economies of scale.

* In the investment world, these companies are referred to as growth stocks. They can be some of the best investments since they can sustain long-term growth in sales and profits.

3. Mature industries have passed the period of rapid growth. The growth of these companies tends to mimic the growth of the economy.

* While cash flow and earnings can still be positive, products become similar across the industry, just as all home computers are similar today. Price competition eventually ensues, and profit margins drop.

* These stocks can be quite attractive for a long period. The growth of these companies tends to be stable and predictable. These companies can also handle a poor economy better than one in a growth industry.

4. Declining industries fail to match the growth in the economy. The railroad or photographic film industries are two good examples. These companies get into this situation by having products or service with declining demand or products replaced by technological advancements.

* These industries are usually poor investments, but they can have growth at times, even though the overall future looks bleak.

* Individual companies within a declining industry can still be good investments. You must be prepared to do a significant amount of research to find these companies.

It’s really a question of risk vs. potential reward:

* Conservative investors should focus primarily on companies in mature industries.
* Investors with greater risk-tolerance should target growth stocks.
* Only the boldest investors should have a significant portion of their portfolio in emerging industries.

Remember, sometimes it’s not the company. It’s the industry. Understand the different stages all successful companies eventually pass through. It could make a big difference in your investing success.

Posted in: Investing

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