Capital Intensive Industries

Not a value investing proposition?



What are capital intensive industries?

They are companies like steel producers, telecommunications companies and airlines.

They also include any other companies that require large amounts of expensive equipment, machinery or planes in order to trade.

They are generally not a value-investing proposition.


Why Generally Avoid Them?

Equipment goes out of date in time and unless the companies continue to inject large amounts of earnings into new equipment, or can reduce costs by leasing, they will lose their competitive edge.

Those earnings will be lost to shareholders. So I ask myself, is the equipment or machinery they are using likely to become obsolescent in the next 5 or 10 years?

Because of the high cost of maintaining their business, these companies are limited in using retained earnings in a way that will enhance future earnings.

Hence their stock prices are likely to go nowhere.

Also, they are more likely to have higher debt in order to finance the capital expenditure. Higher debt increases risk.


Any Exceptions?

Of course, there are always exceptions.

Large-scale mining companies come to mind like BHP Billiton and RIO. These companies need to fund massive rail, port and processing infrastructure to bring massive mining projects on line.

But they also make massive profits, particularly at times when ore prices are at historic highs.

So for these companies I have to make a judgement as to the quality of their mining operations and the diversity of their mineral resources.

The growth in the economies of their major customers, including China and India, is a positive that also needs to be factored in.


In Summary ...

By avoiding most capital intensive companies, I am more likely to find companies that do not use large chunks of their earnings to develop infrastructure or to buy new equipment.


But how to find companies that have minimal capital requirements but can still generate healthy profits?

From a value investing perspective, the answer for me lies in comparing the annual capital expenditures documented in company reports to the annual net profit. The more profit with less capital expenditure the better.

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