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The year is 2030. After a severe economic depression, Elon Musk has been appointed as the chairman of the Fed. His first decision is to replace the U.S. dollar with Dogecoin….
The future is fun to imagine because anything is possible. Yet, trying to economically exploit the future brings a quick reality check. All of a sudden you return from Imagination Land and get back to solid ground.
Read on to learn what are the best industries to invest in right now and what particular details to look for while doing so.
Best for a hedge against inflation: Healthcare and residential REITs
With inflation spiking up to highs not seen since 2008, the cons of the current monetary policy are starting to pile up.
In this environment, real estate investment trusts (REITs) offer a good hedge against inflation. Yet, not all REITs are equal. Healthcare and residential REITs are a prime pick due to their lower elasticity of demand and ability to pass on the cost of inflation on customers.
Best for growth: Data analytics
Between your phone, your car, your customer loyalty cards or a Fitbit on your wrist — data analytics is everywhere. This industry is looking to leverage data to gain insights and optimize business operations.
Two sectors where this will make a big impact are agriculture (maximizing food production) and healthcare (optimizing patient treatment).
Best for long-term: Renewable energy
Renewable Energy Trends, source: Our World in Data
If there’s one topic that seems to make it to almost every debate, it is renewable energy. Anything from Bitcoin to electric vehicles needs a growing amount of energy — but in a sustainable way.
In 2020, annual renewable capacity increased by 45% and energy capacity increase for 2021 is projected to be 90% renewable.
With the Biden administration rejoining the Paris Climate Accord and investing $2 trillion in clean energy with a goal of net-zero carbon emissions by 2050 — it is evident that this sector will enjoy a strong long-term trend. To find out a convenient way to invest in this sector, check out our list of the best industrial ETFs.
What is Your Risk Tolerance?
Risk tolerance will vary among investors but it can be gauged by answering a few questions:
- How much money are you willing to lose?
- How old are you?
- What is the goal of your investment?
- Are you planning to track your investments often?
By answering these questions, you will be able to get a rough estimate of your risk tolerance. On one side of the spectrum, younger, long-term investors will be more risk-tolerant. On the other side, older, short-term investors will be more risk-averse.
What to Look for in a Stock
When it comes to favorable stock attributes there are many different opinions – successful stock investing comes down to finding a promising story and then avoiding overpaying for it. A renowned analyst, Lyn Alden-Schwarzer argues that there are 6 attributes that make a good stock.
Benefits from long-term trends
Change is the only constant in the world. Looking back at the times when the Dow Jones Industrial Average was composed, railroad stocks were riding high. The industry was booming, connecting America and it looked unstoppable.
Today, we know that is not true. Times change — some companies are disruptors and others are disrupted. Imagining the future isn’t easy, but a high-quality stock is one that benefits from the constant change this world goes through.
Has high return on capital
Return on capital (ROC) is a good way to measure fundamental company quality. ROC measures the return a company makes for every dollar they invest in their business.
ROC = Earnings before interest and taxes / (net working capital + net fixed assets)
While averages will vary by industry, a rule of thumb is to look for ROC over 12% and relatively better over the competition.
Builds durable economic moats
When a company begins to achieve high returns on capital, game theory mandates that the competition will appear to try to get some market share. This competition will drive the profits down and closer to the weighted average cost of capital.
An economic moat is a concept coined by Warren Buffett. He referred to the moats used to protect castle walls as a metaphor for imaginary moats that protect the enterprises’ return on capital. There are different types of economic moats but some of the most popular is brand power, network effect, the economy of scales (size advantage driving the marginal cost down), high switching costs and patents.
Enjoys a strong balance sheet
Few things are more perilous to a company than holding a large amount of debt. Although debt/equity is a popular metric to gauge the state of debt, debt/income is a better one — it has smaller industry-based variations.
Debt / income = Net debt / annual net income
Acceptable debt/income ratio is below 5 and ideally below 3.
Employs competent management
In a world where executives often and readily rotate positions, the long-term tenure of senior executives is a positive thing. After all, if a CEO has been around for a while, it is likely they are doing a good job, otherwise a mob of shareholders with torches and pitchforks would be after their head.
As CEO compensation is usually proportional to the size of the company, you need to be careful with CEOs who want to expand for expansion’s sake. Look out for those that focus on profitable growth and smart capital allocation.
Another useful metric to keep in mind is the insider ownership of the company. An old proverb says that insiders sell for many reasons, but buy only for one. Management that invests in their own company do so because they believe in it.
Secures a safe dividend payout
If a company pays a dividend, you should check if that is sustainable. Otherwise, when push comes to shove, and the cash flow dries up, the dividend might get slashed or straight-out suspended.
A rule of thumb is to look for a dividend payout ratio below 50% of earnings and free cash flow. That way, even a recession that cuts the earnings in half won’t endanger the dividend payout. For defensive sectors like consumer staples or utilities, this ratio can be up to 75% as they are more recession-resistant.
What to Avoid in a Stock
When it comes to maximizing the returns, avoiding stocks with certain red flags will help you make better decisions. Here are 3 attributes to avoid when looking for a solid investment.
Using too much leverage
Leverage is a double-edged sword. It doesn’t change the odds of success but simply amplifies the outcome — both positive and negative. This is why excessive leverage can destroy years of work overnight. The recent rise and fall of Bill Hwang and Archegos Capital Management show the bad side of leverage.
To find out the leverage use debt-to-equity (D/E) ratio. You can calculate it by dividing total liabilities by the total shareholders’ equity. While the acceptable ratio will vary by industry, you want it to be low, around 2.0 or lower.
Diluting the shareholders
Although there are scenarios where the best course of action is to raise capital by issuing new shares, look out for companies that often dilute the shareholders. Every time a company issues new shares it is devaluing your stake in it. On the other side of this spectrum, you will find companies that do an excessive stock buyback. If management does it by taking on new debt and support the price it is likely they are after the performance-based compensation. Follow the money and eventually, you will uncover the motives.
Poor employee satisfaction
Employee satisfaction is one of the hidden indicators of quality as there doesn’t exist an indicator that measures it.
Finding out how a company treats its employees will need a bit of detective work and using services like Glassdoor.Look out at wages, benefits and especially at employee treatment in times of crisis. Compare them to the industry average and think twice before investing in poor performers.
Best Online Brokers to Invest in Top Industries
The process of investing is much easier when done through a quality broker. Check out our comparison of the best brokers you can use to start investing today.
Be Fearful when Others are Greedy
John Kenneth Galbraith once said that there are few fields of human endeavor in which history counts for so little as in the world of finance.
Looking at the current state of the financial markets, history shows that its valuations are hard to justify.
In that environment, playing defense becomes more important than chasing growth, because regardless of the quality of an investment — it won’t protect you if you paid a price too high.
Frequently Asked Questions
Which industry will grow in the near future?
While the future is not ours to see, there are few industries showing potential for the near future based on technological trends.
- Data analytics: Data is everywhere around us. More and more companies are relying on this to optimize their operations — especially in the marketing and human resource departments. One of the best clues pointing this out is the rise of the data scientist as a career path.
- Cybersecurity: As businesses continue increasing online operations, cybersecurity importance continues climbing. Cyberattacks, data leaks or ransomware present a potential nightmare for any company. The Colonial Pipeline hack presents just the latest example in a long line of cyber incidents.
- Renewable energy: Fighting back the human-induced climate changes can only succeed with a fundamentally different approach to energy creation. While solar and wind energy have been forming positive trends, just 3% of vehicles currently on the roads are electric. As this number grows (projected to pass 50% by 2040), demand for renewable energy will soar.
What industry is in high demand?
In the aftermath of the 2020 pandemic, the world is currently experiencing a significant chip shortage, and the demand for semiconductors is surging beyond all production capabilities. Other notable mentions include artificial intelligence and commodities like lumber and copper.
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