Two factors to consider when investing in a company is its industry category and life cycle. Industry categories fall into three broad groups: non-cyclical, cyclical and growth. Industry life cycles also fall into three broad groups: pioneering, growth and maturity. Below is a brief definition of industry categories and life cycles.
Noncyclical industries: These are relatively resistant to business cycle ups and downs and can be considered “defensive investments.” Examples are the food and drug producers and utilities. In general, investments in these businesses tend to be less risky, but, therefore, often bring relatively low returns.
Cyclical industries: The opposite of the above, cyclical industries are most affected by downturns and recoveries. Examples are producers of “durable goods,” such as automobiles, heavy equipment, housing materials, etc. When the economy slows, or inflation is rising rapidly, individual consumers and businesses both tend to delay purchases of such goods.
Growth industries: This grouping is less influenced by business cycles than by investors’ expectations that these producers will grow faster than the economy as a whole. Such businesses often concentrate heavily on research (recent examples include lasers, smart phones and biotechnology).
Industry life cycles differ in that the above can go through all of the phases below.
Pioneering cycle: This is a period of strong and rapid expansion because the industry is relatively new (exploiting a technological innovation, perhaps). This is often a period of keen competition as many firms rush to enter the market. Those that succeed reward their investors handsomely, but, of course, most firms will not succeed, with unhappy consequences for the investors. Genetic engineering and Internet-related businesses are industries in the pioneering stage. At this time, it is not clear which of the many firms in these businesses will ultimately be their leaders.
Growth cycle: In this phase, the industry expands rapidly. This tends to be a period of only modest consolidation: many firms sell their products to this growing market. Surely social networking, some areas of medical hardware and oil and gas recovery from fracking are also included in this category.
Maturity cycle: A time of slower growth, stagnation, or even actual decline, with a few surviving firms accounting for nearly all of the industry’s output. Microcomputers, automobile and steel industries are certainly mature. As companies move through this cycle, the potential for further growth, and hence rapid stock price appreciation, goes down; investors look for higher dividends to compensate for this lower capital appreciation.
Quote of the week: “The most difficult secret for a man to keep is his own opinion of himself” — Marcel Pagnol
Bart Ward is the chief executive officer of Ward & Co. Ltd., an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.