Predicting which sector will outperform in next 10 years is a terrible work. You may be right or may be wrong. Chances are, you’ll be wrong 90%.
Nobody can perfectly predict the market flow in next 10 years.
What you need to do is just reduce the odds by investing in the companies with high certainty.
That’s what Warren Buffett do.
He invests in the company which he can predict – what it be like in after 10 years.
Like Coca Cola or say Wimbley Chewing Gum. He once said “I don’t think the internet will going to change how people chew the gums”
But still, it’s good to get an overview on which sector is more certain and which are not.
There are 3 types of stock market sectors:
- One, which have high-profit potential and a very low overall dividend yield because the company is reinvesting the bulk of the earning in expansion like tech sector, consumer goods sector etc (aka growth sectors)
- Second, whose earnings are high but lacks growth so they are distributing the high amount of profit as dividends like tyre sector, government sector etc (aka value sectors).
- Third, which fluctuates widely over swings in the business cycle. There sales and profits vary largely like sugar sector, textile sector etc. (aka cyclic sector).
Here comes the analytical part.
- Growth Sector stocks are already overpriced. Investing in this sector is quite risky, However, multi-bagger potential does exist in this type of stocks. Results are also extraordinary in the growth sector if you made a right move at the right time.
For example Tech sectors. They have industry PE ratings at around 20 which mean you’re getting 1 Rupee for every 20 invested in the industry.
Have a look:
Img – moneycontrol (web)
Why they attract high PE ratings as compared to many other sectors?
Remember, high growth companies attract expensive P/E rating. People are highly bullish on this sectors because there is very high growth technology, especially in India so investors reversely value it high.
- Value Sector is highly preferred by senior citizens as it pays high dividends but growth is very low so it lacks multi-bagger potential. This type of sector is the best fit for the people who are less risk taker and seeking for a regular income.
For example tyre companies. All the stocks in this sector have very deflated PE ratings.
Img – Screener
Still, some scholar says it’s a cyclic sector other says its value sector. I consider it value sector.
Government-owned stocks are also value stocks. They have high dividend yield like REC, PFC, MOIL etc.
- Cyclic sectors are highly uncertain. It remains high at sometimes and lows at other time. It’s hard to predict their future road. They are highly dependent on external factors and economy of the nation.
I still remember the price of sugar 6 months back, when I use to go to the nearer superstore with my father. The price of the sugar then was Rs 30 to 35 per kg. And now, within 6 months, it shoots up to Rs 45 per kg.
And so do the stocks of the sugar industry.
Img – business standard
Sugar industries are the best example for the cyclic sector. Sometimes, they touch the sky and at other times they are below the ground. They were struggling from last 3 to 4 years but in 2016, sugar stocks broke the record. They are Most inflated stocks of this year. This is what known as the cyclic sector.
An example of deflated cyclic sector is textile. This sector is struggling to get more than enough results now but will definitely shoot up in future and only God knows – When?
You can figure out the difference between PE ratings of different sectors. that’s what the biggest flaw with PE. It doesn’t consider several factors like growth which is why sectors with equal earning have different PE ratings.
Flaws associated with PE ratings.
PE can’t be used to compare stocks with different sectors because they have different PE ratings based on their diversified factors. So, don’t always rely on PE ratings to compare industries.
Therefore, PEG ratio was introduced. I had already written an answer for explaining the same. Here it is:
PE was highly used by many analyst and fellow investors but there is a huge flaw in this ratio.
It doesn’t consider growth of the company and high growth companies attract expensive P/E rating.
Therefore, you can see that Tyre/Textile companies have a low PE as compare to Tech companies.
There is low growth in former sector and high growth in later sectors.
So to create a base ratios for all the listed company, PEG ratio was introduced. It index all the companies to a common base.
Formula = PE/Growth rate
Here’s the conclusion:
- PE ratio can be used to compare companies in the same sector.
- PEG ratio can be used to compare all the listed companies.
But still, it’s not an easy task to predict the growth rate of any sectors or stocks.
Is it beneficial to invest in sectors?
According to me – NO.
Instead find the stocks in every sector with good financials and also with an economic moat power – this is the crux. One who understand it are the true value investors.
Side note: The term economic moat, coined and popularized by Warren Buffett, refers to a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms. (source: investopedia)
Because companies with economic moat have a competitive advantage. So even at the bad times when industries are struggling to earn every single penny, these companies enjoy high earnings ratings.
How to find companies with a high economic moat?
There is 2 approach:
- The loyalty of its customer.
- The quality of its product.
- The talent of its management.
- The value of its brands.
- The high efficiency of its operations.
- Low Strength of competitors.
- The long-term prospects of the business etc.
Any of these criteria, either alone or in combination would be helpful to understand a moated business.
It includes analysing certain elements of financial statements like:
Operating profit margin.
High OPM shows that business has potential to observe the loss in bad times.
This is what percent of the market is covered by the company. You can also look over market cap % of the company to get a round figure of market share.
Profit margins at different point of expenses also play a great role. It also includes analysing all the expenses like COGS, interest rates, taxes etc.
Annually published reports are the gold mine for value investors. Here you can get everything about the business operation and its industry. There are many industries which deal in great business but still are unknown. Annual reports are where you can find that company.
You all know the company behind Maggi?
Of course, Yes. Nestle as it is highlighted again and again but……..
Do you know the cycling brand – BSA and Hercules?
Do you know the listed company behind these brand?
Most of us, don’t know but still these brands have a great market share with sustain future market.
It’s Tube Industries. If we peek into its annual reports then we can uncover much-hidden golds. There are many companies with such economic moat power but are highlighted.
Sector investing is the protection against ignorance. It makes very little sense for those who know what they’re doing.
If some investment advisers are trying to sell you on the idea of investing in index or sector, it is because they don’t know what they are doing when it comes to investments and they want to protect you from their ignorance.
The point is simple, instead of investing your money in many mediocre companies, why don’t you invest it in selected outstanding companies. But to find that selected companies, you need to understand the industry and business economy of the stock.
But if you don’t know what you’re doing, sector investing is a wise course in that it will offer you a protection against losing everything and maintain the potential of average growth over the long run. However, it is not going to make you rich.
Well said: Too much of good thing can be wonderful. All that you need is patience, to strike gold with moat based investing.
3 types of sectors in stock market & associated stocks + Why Moat based Investing is Awesome?