Most budding value and fundamental investors, myself included, usually jump in to analyze a company directly when trying to determine it’s suitability for investment without spending as much time analyzing and understanding the industry and the macro environment the company plays in. In most cases, it’s not that we don’t know that the industry is important, but that we have a basic familiarity with the company’s industry which leads us to just assume the basics are covered and all that matters is the specific company and how they’re doing. At the most, we might compare them to a few other companies in the same industry to judge their metrics or valuation compared to their peers but that’s it.
Lately, though, as recently as the last year or two, I’ve come to realize the bigger importance of understanding industries, their dynamics, trends, driving factors and so on before narrowing down to select companies. It’s a fallout of the recession and then the oil prices crash, I’ve seen the light of macro-economic head or tailwinds being just as important to the success of a business as their management, resources and competitive advantage.
Imagine looking at a great tech company during the tech crash of early 2000s, you would not have been spared that agony. Or imagine knowing that recessions tend to kill oil demand, which, combined with increased production spelt doom for oil stocks a few years on. I didn’t always know that, but now I do.
So these days, I start my analysis of any company by studying their industry intricately. Who are the top players? What are the main drivers? What governs demand and supply? Is it growing or shrinking? How is it financed? And a whole lot of other questions. By the time I understand all of these, I’m in a much better position to analyze the individual companies that catch my fancy.
It’s much better to invest in an industry experiencing a secular boom period with great fundamentals, because even an average company in that industry will make good returns. That is much better than blindly swimming against the current where you’re picking a good company in an industry in down turn or crash. Even if you turn out alright, it will still come with way too much stress to be worth it.