To identify industries in the industrial materials sector with the best long- term fundamentals, figure out "which industries have already undergone significant consolidation. Then, look for the low-cost producer relative to domestic and foreign competitors, and check that it is in excellent financial health and has additional revenue streams from value-added products or services that supply a variety of industries. Finally, determine what you think the company's stock is "worth, subtract a fair margin of safety, and wait for a good buying opportunity.
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, chemi
cals) and producers of noncommodity value-added goods and services
(machinery, some specialty chemicals).
• Buyers of commodities choose their product on price—otherwise, com
modities 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 advan
tages; the exceptions are those in concentrated industries (e.g., defense),
those with a specialized niche product (e.g., Alcoa, some chemicals mak
ers), and, above all, those that can produce their goods at the lowest cost
(e.g., Nucor).
• Only the most efficient producers will survive a 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.
