Industrial goods sector includes companies that produce goods that are used for construction and manufacturing. Industrial goods are one step farther than basic materials, so many companies involved with the basic materials sector also sell industrial goods. The line between these two sectors is somewhat fuzzy.
The industries within this sector are industrial machine tools, construction, cement and metal fabrication, and aerospace and defense. It is heavily affected by the business cycle. When the economic situation is rough, companies will postpone expansion and spend less money on industrial goods. Most of the companies in the also industrial goods have a high proportion of fixed assets, which creates large swings in profitability.
MACHINERY AND TOOLS
Machinery and tools industry of the industrial goods sector refers to the small tools and industrial equipment that companies use to manufacture other types of machines or use as components in larger machines. This industry of industrial goods can also include farm machinery.
These segments of the industrial goods sector are very cyclical, so efficiency and inventory management are important evaluation tools. Efficiency for this segment is often measured by return on assets, where a good return is better than about 7% ROA. For inventory management, the general rule is that if you see that inventories are rising quickly, this is usually a sign that the company’s profitability will suffer in the future.
Machinery and tools are huge long-term investments for customers, so they are usually careful to pick the highest quality equipment even if it has a higher price. Customers in this segment of the industrial goods also prefer tools that can be upgraded in an incremental way without replacing the entire machine, and there is a great demand for service agreements attached to the machinery. This means that brand recognition and advanced technology can be important points for future success, but efficiency and inventory management will still offer the best investment returns.
CONSTRUCTION AND BUILDING MATERIALS
Construction & Building Materials is an industry of the industrial goods sector which are related to building, from the materials and equipment used to make infrastructure and homes to the general contractors that also help with planning and design.
All businesses related to this kind of industrial goods are highly cyclical. Their cycle generally follows the price of housing, but profitability of companies in this segment is also affected by commodity prices.
There is some differentiation in this market segment. Representatives of this industry of the industrial goods, firms such as Caterpillar, have built a strong brand name and loyal following for their products. In many cases this following is based on superior technology, giving the firm a premium pricing power.
Being aware of the long term cycles is important for investments in this segment. You can track this cycle by following inventories or by tracking interest rates. A buildup of inventories is usually a bad sign, while low interest rates usually signal a boom in construction. Big brand names are likely to continue to be the leading investment options.
AEROSPACE AND DEFENCE
Aerospace & Defense industry of industrial goods includes anything related to the production of airplanes and helicopters, or military tools such as tanks and ammunition.
This segment of industrial goods is highly cyclical and highly concentrated with a few very large companies. The major factors for this segment are government regulation, long term contracts, and government defense spending. R&D spending is also an important part of this segment.
The two main customers for this segment are airlines and the United States’ military. Airlines, as a general rule, are very unpredictable customers. Airlines are a very cyclical purchasers and have a tendency to cancel orders. On the other hand, the government rarely cuts defense spending programs, offering stable contracts of 3 to 5 years.
Efficiency is important, but the largest factor in this segment is probably government spending. Government spending provides defense firms with R&D funding that they often use to improve their commercial products. As you might predict, defense spending booms during wars.
The introduction of a new technology or the announcement of a new war would be good times to consider investing in aerospace and defense.
WASTE MANAGEMENT AND POLLUTION CONTROL
This segment of the industrial goods includes companies that collect and dispose/recycle waste or remove pollution from the soil, air, or water. It is a relatively concentrated, stable segment, and is not very cyclical.
Companies involved in waste management and pollution control often average very high-profit margins of over 25% and have very stable cash flows. They also have geographic and regulatory competitive advantages, and generally have acceptable debt/equity ratios of around 1.0 or less.
This segment of industrial goods almost always offers good opportunities for investment. The two most predictable types of companies in this segment of industrial goods are the largest companies and the niche companies offering special services. Technological advances can fuel the growth of smaller companies while larger companies rely on efficiency and acquisitions. Even without significant growth, a profitable waste management company is always worth considering.