A Guided Tour of the Market 11

Industrial Materials

The industrial materials sector includes a broad array of companies, which make everything from the fragrances used in soap to bulldozers and heat-seeking missiles. The general business model is simple: Industrial materials companies buy raw materials and facilities to produce the inputs and machinery that other firms use to meet their customers' expected demand for goods.

We divide industrial materials into two groups: (1) basic materials such as commodity steel, aluminium, and chemicals and (2) value-added goods such as electrical equipment, heavy machinery, and some specialty chemicals. The primary difference is that commodity producers have little or no influence on the price of the products they produce. Makers of value-added industrial materials, on the other hand, may be specialized enough or improve a customer's business enough for the manufacturer to share part of that benefit in the form of a premium price.

Although basic materials industries do have significant barriers to entry – the cost of constructing a new steel, aluminium, or paper processing plant is steep – stiff price competition makes for mediocre profits at best.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

Investor's Checklist: Industrial Materials

This is a very traditional Old Economy sector, with many hard assets and high fixed costs.

Industrial materials are divided into commodity producers (steel, chemicals) and producers of noncommodity value-added goods and services (machinery, some specialty chemicals).

Buyers of commodities choose their produce on price - otherwise, commodities are the same product, regardless of who makes them.

The sales and profits of companies in this sector are very sensitive to the business cycle.

Very few industrial materials companies have any competitive advantages; the exceptions are those in concentrated industries (e.g., defense), those with a specialized niche product (e.g., Alcoa, some chemicals makers), and, above all, those that can produce their goods at the lowest cost (e.g., Nucor).

Only the most efficient producers will survive the downturn:  The best bet is to be the low-cost producer and owe little debt.

Asset turnover (total asset turnover [TATO] and fixed asset turnover [FATO] measure a manufacturing firm's efficiency.

Watch out for industrial firms with too much debt, large underfunded pension plans, and big acquisitions that distract management.


Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey



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