Wednesday, 25 May 2016

Invest in the Company, Not the Industry

Ever catch yourself saying "(Currently hot industry) looks like it's going to grow, so (company in the industry) is definitely going to grow in the future as well"? Some times I find myself doing it as well, but we should create a clear distinction between the company and the industry. Just because a company is in a hot industry doesn't mean that it will be able to grow in that industry as hot and growing industries tend to attract the most competition

(Image source:, PublicDomainPictures)

So, instead, we should look at the company and not just the industry. To a certain extent, the industry plays a role in the growth of the company (it's hard for a company making camera films to do well in this market), but it must be able to maintain it's market share in the industry even as it grows which can be difficult as higher growth rates and larger profit margins would naturally attract more competition that would undercut the company's prices and offer better quality products. So, what does the company have to offer that would be able to keep the competition at bay

If we look back at history as well, one of the best performing companies of the 20th century would have been in a company called Altria, which produces cigarettes. Yes, cigarettes. An industry with almost no innovation and growth (annual cigarette consumption in the US has been declining since the 1980s). But this has in a way contributed to its success. Firstly, the lack of growth and the "sin stock" label kept investors away, so that those that did invest in it, got it at a cheap price and therefore a high return. Secondly, the lack of innovation and change in the industry keeps the business sustainable and keeps R&D costs low

In a rapidly growing industry, there is going to be change and a lot of it. So, in order to keep up with these changes, companies need to keep up large R&D budgets to ward off competitors and even then, it does not mean that they would be able to always remain one step ahead as their competitors are doing the same. Companies such as Apple and Samsung have to constantly push out new products just to maintain their market share and if they push out a few flops, there businesses are likely to lose a lot of market share

There are other factors that may have contributed to the success of the company as an investment, but the two mentioned above is likely to have helped quite a fair bit in its success

Companies that are in boring industries or ones that are in decline usually, usually, make better investments but as mentioned in this post, we should focus on the merits of the company that will position it better for future growth. So, while we shouldn't invest in a company that's in an industry going the way of the dodo bird, we shouldn't focus on the industry that the company is in. Instead, we should focus on its competitive advantages within the industry that would allow it to maintain and even grow its position within that industry

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