The Challenges of Picking Winning Investment Industries

Investors often fail to predict winning industries, leading to disappointing long-term returns.

### The Challenges of Picking Winning Industries in Investing
* 📉 Betting on the success of a single industry in investing is often a mistake, as history shows that **winning industries do not guarantee winning stock returns**.
* 📊 Over the decades, industries like electronics equipment have seen **impressive annualized returns**, but they are rarely the **top performers** in the following decade.
* 📈 In fact, from 1934 to August 2024, industries that dominated one decade typically **trailed the market by an average of 2.6%** in the next decade.
* 📉 A mere **17 out of 49 US industries** have outperformed the market from July 1969 to August 2024, highlighting the **difficulty of consistently picking winners**.
* 💔 Investor behavior often leads to poor timing, with many focusing too heavily on **technology stocks**, resulting in **significant return gaps** as noted in Morningstar's 2024 report.
* 💰 Stocks are claims on future earnings, and **high expectations can lead to disappointing returns** due to earnings dilution in rapidly growing industries.
* 📉 Historical data shows that industries with high growth do not always yield the best stock returns, as evidenced by the performance of sectors like **tobacco and entertainment** compared to **tech**.
* 🔍 Rather than attempting to pick winning industries, a more prudent strategy is to focus on **cheaper stocks within diversified industries** to **manage risk and enhance expected returns**.

Why Betting On “Winning” Industries Almost Never Works

I post videos on investing, financial decision-making, and living a good life.

My name is Ben Felix. I am a Portfolio Manager and the Head of Research at PWL Capital. I am a CFA charterholder and CFP professional. I am securities licensed in Canada by CIRO.

All channel content is produced and owned by PWL Capital Inc.


Ben Felix

The Challenge of Betting on Winning Industries

Investing in a single industry's success is often a mistake, as the composition of leading industries changes over time.

Despite technology's recent dominance, picking the next winning industry is challenging and historically, top-performing industries rarely maintain their success in the following decade.

The commonality among these industries is their inability to repeat as top performers, making it difficult to predict future investment returns.

Top-performing industries often trail the market in the subsequent decade, with an average annualized difference of 2.

Most US industries have underperformed the market in the long run, with only 17 out of 49 beating it from 1969 to 2024.

Investor behavior, such as performance-chasing and timing the market, has led to significant return gaps, particularly in tech-heavy sectors like the NASDAQ.

The Complexity of Industry-Specific Investment Returns

Industry-specific risk can lead to unpredictable investment returns, making it difficult to determine which industries will succeed.

The price paid for a company's future earnings is crucial in determining expected investment returns, with high expectations requiring even better realized earnings for abnormal stock returns.

Per-share earnings growth, rather than industry-wide growth, is what matters to investors, leading to earnings dilution and slower growth in per-share earnings for companies in rapidly growing industries.

The original stocks in the S&P 500 have outperformed the index from 1957 to 2003, driven by high investor demand for certain industries.

Sectors that expand dramatically, like financials and technology, often produce mediocre returns, while those that shrink, like energy, can outperform the index.

Recent trends show that stocks added to the S&P 500 tend to have high valuations and underperform in the following year, suggesting that less exciting industries with lower valuations may offer better performance.

The Challenges of Picking Winning Industries

Diversifying across industries based on aggregate characteristics, rather than focusing on higher expected return stocks, can lead to unjustified portfolio concentration.

High expected growth industries often disappoint, and the best-performing industries in the past tend to underperform in the future.

Systematically tilting toward higher expected return stocks within industries while maintaining broad diversification may be a more effective strategy for investors seeking higher returns.