Some Industries Are Better Investments Than Others
Some industries are more predictable than others and provide better returns on capital over time.
In November 2016, Credit Suisse looked at the equity returns of 10,000 companies in 68 global industries.
They used the median value of these over the last five years. The following figure shows CROIC (cash return on invested capital).
The figure clearly shows that some industries create great value, but also that some industries do not. The graph shows the difference between CROIC (cash return on invested capital) and the cost of capital.
However, we also see that some companies do not create value even among the best industries and that some companies create value even in bad industries. In general, the survey shows that there are certain industries that may be best to stay away from, such as shipping and shipyards.
Every year, Credit Suisse publishes a book called Credit Suisse’s Global Investment Returns Yearbook. In the book for 2015, the authors Dimson, Marsh, and Staunton, the authors behind the book Triumph of the Optimists, reviewed the returns of 15 industries in the USA from 1900 to 2015.
In total during the period, the annual return for all shares was 9.6%. The worst industry was shipping with a return of 6.4%, and the best was tobacco shares with 14.6%, despite the fact that the number of smokers in the US has fallen every year since 1970.
Shipping is a hugely capital-intensive industry, and not least cyclical, while tobacco requires minimal capital and has large margins.
Tobacco companies can simply increase the price even if the number of smokers falls. In shipping, it is very difficult to gain any competitive advantage. The competition is global and the focus is usually on price.
In general, the survey shows that cyclical and capital-intensive industries have shown weaker development than the market.
The figures for the UK show that alcohol companies gave the best returns, while commodity stocks and banks gave poorer returns than the market.
Within industries, there are several “sub-industries”. Industry analysis can help you a lot to understand where you can make money in the industry. As an example, Credit Suisse uses the aviation industry.
The industry consists of a number of different companies and subcontractors: airlines (SAS, Norwegian, Delta, Southwest, etc.), airline manufacturers (Boeing, Airbus), freight (FedEx, UPS), travel agencies (Expedia, Booking.com), logistics/distribution (Amadeus, Saber), airports (Gardermoen, Arlanda), finance (banks, leasing), subcontractors (Pratt & Whitney, Rolls Royce) and ground support.
If we look at how much capital is required and what the capital gives in return, Credit Suisse reproduces this interesting graph from the International Air Transport Association (2004-2011).
The Y-axis reflects profit on invested capital minus the discount rate. As we can see from the chart given above, airlines and airports use almost all capital for the entire industry as a whole but are unable to generate returns above the discount rate.
It is the least capital-intensive part of the industry that runs off with the entire profit. Because airlines and airports spend so much capital, the industry as a whole “destroyed” $ 17 billion during this period.
Although the graph only reflects a period of 7 years, it gives a strong indication of where it is best to invest. Airlines have a history of low returns.