Why Betting On “Winning” Industries Almost Never Works

Summary

In this video, Ben Felix, Chief Investment Officer at PWL Capital, explains why betting on specific industries for investment may not be a wise strategy. He highlights the challenges of predicting winning industries, drawing on historical examples where top-performing sectors often underperform in the following decades. Felix emphasizes that high growth industries often have inflated valuations, leading to disappointing returns. He advises diversifying across industries and focusing on cheaper stocks within those industries for better returns, rather than making speculative bets on industries. The video underscores the importance of avoiding performance-chasing behavior and sticking to a diversified portfolio.

Takeaways

• 😀 Picking winning industries is more challenging than it seems, and often leads to disappointing returns.
• 😀 Over the decades, industries with high growth rates have often underperformed in the subsequent decade.
• 😀 The stock market often reflects the growth expectations of an industry, making it harder to achieve high returns in high-growth sectors.
• 😀 Most industries underperform the broader market over the long term, with only 17 out of 49 U.S. industries beating the market since 1969.
• 😀 Technology stocks have dominated in recent years, but focusing solely on them may lead to poor investor behavior and returns.
• 😀 A common investor mistake is performance chasing, often causing them to buy high and sell low, which reduces returns.
• 😀 High-growth industries typically have high stock prices, which makes it harder to earn high returns.
• 😀 Industry-wide growth does not always lead to higher earnings per share growth due to competition and dilution.
• 😀 Stocks added to indexes like the S&P 500 tend to underperform because they are often added at high valuations.
• 😀 Instead of betting on entire industries, investors should consider tilting toward cheaper stocks within industries to maintain diversification and avoid high-risk concentrations.

Q & A

Why is betting on the success of a single industry considered a mistake for investors?

Betting on a single industry is risky because predicting which industry will outperform the market is difficult. Historical data shows that even industries with strong growth often fail to maintain that success in the future. Additionally, industries can face disruptions or challenges that investors may not anticipate.

What is the primary reason why winning industries do not always deliver winning stock returns?

Winning industries often come with high valuations due to expectations of future growth, making it difficult for stocks in those industries to deliver high returns. As a result, the growth in earnings often doesn't match the high expectations set by the market.

How does the performance of industries from decade to decade illustrate the challenges of predicting winning industries?

Industries that performed well in one decade often fail to maintain their top position in the following decade. For instance, sectors like office supply, aircraft, and gold stocks had incredible returns in specific decades but underperformed in the subsequent ones, highlighting the unpredictability of long-term performance.

What is the relationship between industry growth and stock returns?

Industry growth does not necessarily translate to high stock returns. Even when an industry grows in total earnings, stock returns are influenced by per-share earnings growth. This can be diluted by factors such as increased competition and capital raising within the industry.

Why do high-growth industries like technology often fail to produce the highest stock returns?

High-growth industries, such as technology, often face high prices and increased competition. While the total industry earnings may grow rapidly, the per-share earnings growth, which directly affects stock returns, often grows more slowly due to earnings dilution.

What does the S&P 500 reconstitution tell us about the relationship between industry growth and investment returns?

The S&P 500's reconstitution, which adds and removes companies annually, shows that industries with high valuations often underperform after being added to the index. This supports the idea that high valuations, typically associated with growth industries, lead to low expected returns.

How does investor behavior affect returns when investing in sector-specific funds?

Investor behavior, such as chasing past performance, often leads to poor timing in sector-specific investments. This behavior causes investors to buy high and sell low, which results in lower returns compared to the actual performance of the fund.

What are the two main problems with picking winning industries before the fact?

The two main problems are asset pricing and industry-specific risk. High-growth industries often have high stock prices, making it harder to earn good returns. Additionally, industries can face risks, such as disruption, that may undermine their potential for future growth.

Why do industries with lower relative valuations tend to perform better than those in newer or exciting sectors?

Industries with lower relative valuations tend to perform better because they are often less exciting and trade at lower prices. In contrast, newer industries with high valuations have lower expected returns, as their growth potential is often overestimated.

What is the recommended approach for investors who want higher expected returns than the market index?

Instead of betting on specific industries, investors should focus on tilting their portfolios toward cheaper stocks within industries while maintaining diversification. This approach minimizes concentration risk and is more likely to lead to better returns over the long term.