Sectors in the Listed Space: An Investment Perspective

Introduction

Businesses having limited capital requirements can either be financed individually or the required money can be pooled from a small group of people i.e. family and friends, in exchange for a share in the business. These are small businesses across various sectors and this financing framework is called private equity.

When the existing business grows bigger or someone (an individual, a group, or the government) wants to start a business at a large scale, the capital requirements are many times more. Although money can be borrowed from banks, it is limited and has to be returned with interest over an agreed time frame, regardless of the success or failure of the business. In this scenario, the existing or new businesses get listed on the stock exchange and offer their equity to the common people and institutional investors in exchange for funds. This financing model is called public equity. Unlike private equity, in this case, an elaborate secondary market also exists where the shares can be traded subsequently.

Therefore, in the stock market, you can either subscribe to the shares being offered by a company or you can also buy them later from the other counter (secondary market). In the stock market, there is a wide variety of listed businesses from all sectors of the economy.

Every business has its own unique characteristics and the market, as a whole, offers tremendous diversification opportunities to the investor. Against this backdrop, I will briefly cover the details of various sectors in the listed space, their peculiarities, and how an investor should look at them, keeping in view his expectations and investment goals. This article specifically pertains to Pakistan Stock Exchange, however, is generally applicable to all stock markets.

Automobile Assemblers

Mainly, the constituents of this sector are the subsidiaries of big international auto manufacturers. Other peculiarities are as under:

A high capex (capital expenditure) business.
Competitive and cyclical sector.
B to C (Business to Consumer) business model.
Substantial funds are required for R&D.
Good businesses in this sector have strong brand equity and pricing power.
Evergrowing demand for automobiles in a developing county.
Stable business with high growth prospects.
The sector, as a whole, is in the early stages of a major disruption due to the advent of EV technology. The players doing well in this technology will likely be the ultimate winners.
Recommendation. An investible sector after thorough research. Market leaders should be considered.

Automobile Parts and Accessories

The characteristics of this sector are as under:

B to B (business to business) business model. However, tyres and batteries have a fairly strong B to C component as well.
Highly dependent on how the automobile sector performs.
Recommendation. Not recommended for investment. The automobile assembler sector may be preferred.

Cement

There is an ever-growing demand for cement in a developing country. Other characteristics of the sector are:

A commodity business. Brand building is not possible. Weak pricing power.
Earnings are sensitive to international coal prices.
Highly cyclical. Closely aligned with the real estate sector.
Difficult to scale.
A high capex and low ROCE (return on capital employed) business.
Due to heavy freight charges, the geographical location of a manufacturing facility is a limitation. It has to be located at a place where raw material (limestone) is available in close proximity and the target market is also nearby. Environmental degradation is also a concern.
Export to far-off countries is not feasible if the factory is located away from the port. However, the product can be exported to neighboring countries.
Recommendation. Not recommended for investment, especially for the long term. However, if someone has a good knack for understanding market cycles, the cement sector can prove to be a bonanza. Another approach could be to invest only in the market leader i.e. Lucky Cement which has a diversified portfolio, in addition to managing the core business very well.

Chemical

The constituent companies manufacture a wide range of chemicals and every company has to be analyzed separately. This is a specialized investment avenue. Most of the companies have a B to B business model. However, there are some B to C companies as well e.g. paint and toothpaste manufacturers.

Recommendation. Generally not recommended for a person who doesn’t have ample knowledge of the industry. However, paint and toothpaste manufacturing companies can be considered after due diligence.

Commercial Banks

After privatization in the 1990s, commercial banks, by and large, have been a success story. Following may be considered while investing:

The sector is pretty competitive, especially for the new entrants, however, established and big players have a very bright future.
The big five except National Bank i.e. MCB, United Bank, Habib Bank, and Allied Bank are stable and growing businesses.
A well-regulated sector, hence quite safe for the investor.
Some 2nd tier banks are also quite promising.
Good banks have a well-diversified range of products and solutions that enable them to make money consistently despite economic cycles.
Recommendation. Big and some 2nd tier banks are safe investment bets and should be considered after research, especially by those who are interested in regular dividend income.

Engineering

The constituent companies mainly manufacture steel which is used in buildings and infrastructure. Other characteristics of the sector are as under:

A cyclical business closely aligned with real estate.
Generally a low ROCE business.
Building a brand is difficult. Low pricing power.
Sensitive to prices of raw materials and energy costs.
Recommendation. Not recommended for investment, especially for the long term. Like cement, may be considered by someone who wants to and can play the economic cycle.

Fertilizers

In an agricultural country, fertilizers will always remain in high demand. Peculiarities of this sector are:

There are only a few significant players in the sector.
It is a commodity-like business, with weak pricing power.
Predictable business with no disruption expected.
As natural gas is a raw material for fertilizers, the depleting gas reserves in the country is a concern.
Generally, these are stable businesses with fairly good earning ability and reasonable ROCE.
Recommendation. Recommended for investment, especially for defensive investors who are interested in regular dividend income.

Food and Personal Care Products

This sector may contain some of the investors’ “darlings”. This is an interesting space. Some of the characteristics are as under:

Highly competitive sector.
Normally a low capex, high ROCE business.
Brand equity is relevant here. Big brands are in a position to jack up prices at will.
There is an ever-increasing demand in this sector, especially in a developing country. Growth prospects are high.
Good stocks in this sector are already quite expensive with a high P/E ratio.
Recommendation. Recommended for investment.

Oil and Gas Exploration Companies

There are only four companies in this sector. Two of them are owned by the Government. The sector characteristics are as under:

A commodity business with no pricing power. Crude prices are determined internationally.
A high capex business. New discoveries are critical to growth.
Inefficiencies exist in government-owned companies due to political/ bureaucratic interference and slow/ faulty decision-making.
Regular dividend income.
Recommendation. If at all, only privately owned companies may be considered for investment.

Oil and Gas Marketing Companies

Characteristics of this sector are as under:

No pricing power. Commodity business.
Margins are determined centrally by the Government.
The companies can neither compete on brand nor on price.
Growth is possible only through increasing sales volume.
The biggest market share is with the Government-owned company: PSO which is saddled by circular debt.
Recommendation. It is better to avoid this sector for investment. However, some private companies with a strong balance sheet may be considered after thorough research.

Paper and Board

Characteristics of this sector are as under:

A low capex, B to B business.
No brand equity. No pricing power.
Growth is possible due to ever-increasing demand.
Recommendation. It is better to avoid this sector.

Pharmaceuticals

This is an important sector with bright growth prospects. Other peculiarities are:

Brand building and creating a monopoly is possible.
However, generic medicines can be a disruption.
Medicine formulae can be patented to create a strong moat and pricing power.
A non-cyclical sector.
The demand is likely to continue growing.
Recommendation. Recommended for investment after thorough research.

Power Generation and Distribution

The main characteristics of this sector are as under:

A commodity like business.
No brand, no pricing power.
Encumbered by serious cash flow problems due to circular debt.
Stable business with sufficient dividend-paying capacity provided the cash flow is predictable.
High capex business. Scaling is difficult.
The business is subject to disruption by hydel power and alternative energy.
Recommendation. Generally not recommended for investment. However, big players with well-diversified power generation capacity may be considered for the medium term (5-7 years).

Refinery

This sector falls between the exploration and the marketing sectors in the fuel supply chain. Peculiarities are as under:

No brand, no pricing power.
Oil prices are dictated internationally and the sale margins are controlled by the Government.
A commodity business.
Recommendation. Not recommended for investment.

Technology and Communications

The characteristics of this sector are:

The business has two main components: hardware and software. The software is a low capex business. Relies heavily on innovation and creativity. Whereas the hardware component may involve high capex for infrastructure but also depends on innovation and emerging technologies.
Vulnerable to frequent disruptions.
Good companies are expensive with a high P/E ratio.
Rapid growth is possible as technology is evolving and the demand is growing.
Brand building is possible.
The sector enjoys pricing power.
An export-oriented sector.
Recommendation. It is a double-edged sector. Recommended for investment after thorough research.

Textile Composite

The characteristics of the sector are:

B to C business.
Brand equity is relevant. Strong brands enjoy pricing power.
An export-oriented sector.
A non-cyclical business.
A competitive and crowded sector.
Low ROCE.
Recommendation. Offers limited investment opportunities that can be discovered with thorough research.

Textile Spinning and Weaving

This sector provides raw materials for the textile composite sector. The characteristics are as under:

B to B business.
Brand building is not possible. Weak pricing power.
Recommendation. Not recommended for investment.

Tobacco

The peculiarities of the sector are:

B to C business.
Brand equity is relevant. The sector enjoys pricing power despite a strong anti-smoking drive and restrictions on advertising.
A high ROCE business with stable and growing earnings.
A non-cyclical sector.
Recommendation. An investible sector purely on financial grounds. However, may not be considered by someone who is concerned about the negative role of tobacco in human health.

Conclusion

This article is aimed at briefly covering the basic characteristics of various business sectors in the stock market which should be considered by an investor while making investment decisions. Every business caters to a specific market need. It has its own peculiar challenges and growth prospects. An investor cannot possibly make an investment without having at least a basic idea about how a company makes money.

How did you find this content? Please comment and give suggestions, if you have any.

My other articles you may find useful are:

How to Make a Personal Financial Plan – Basic Considerations

Personal Finance – A Suggested Checklist

Investment vs Speculation

A Brief History of Money

Why I Started a Blog on Personal Finance

Anatomy of Financial Risk

Debt, Equity, and Real Estate: An Overview

Retirement Planning

How to Compare Equity and Real Estate as Investment Options

How Stock Market Works and How to Work in Stock Market?