The FTSE has been going nowhere for the past seven weeks. There is no clear direction. But that doesn’t mean you should stay out of the market. On the contrary, you should use this time to identify sectors where you can find good shares at good prices. Let’s look at how you can do that.
In fact, the best strategy to use in uncertain times like this sounds remarkably simple. You just need to find sectors and stocks capable of long-term predictable growth. To do this you will need to ignore many City investment ‘fashions’ where these are not underpinned by strong rationale.
You see, predictable growth renders short-term movements unimportant since the long-term direction is up. The short-term moves in the market are just ‘noise’. You need to ignore that noise so that you can focus on finding the sectors and companies with real potential.
And to find this sort of potential, we need companies in sectors that tap into long-term trends that drive growth rather than from sectors that depend on the economic cycle.
Three important levels to an investment theme
We can call these long-term trends investment themes. And I see three levels to an investment theme. The first is the recognition of the trend and the reasons why it will persist long term. The second level is the identification of the specific sectors or subsectors strongly influenced by that trend. And the third level is the investment angle used to select the type of company most likely to benefit. Let us take an example...
One important trend I’m interested in is the essentials of life, such as food, health and energy. The demand for these is rising. That’s because firstly the world population is rising. But it’s also because people in developing and emerging economies are getting richer. Therefore they expect improved diets, health and living standards.
In The Right Side issue of 11 June, I discussed the way in which the health trend was developing. Patients are demanding improved treatments but health costs are rising inexorably. This is putting increasing strain on health budgets. One result is the growing importance of generic drugs which are much less costly than patented pharmaceuticals and in many cases are just as good. You need to understand this trend and select the global generic drug company with the best prospects.
The energy trend again ties into the increase in population and living standards. More people want cars, air conditioning, air travel and many other luxuries. And in China, peasants are leaving behind them their life on the land. They are moving to work in new factories and adopt an urban lifestyle. These factories need new power stations to supply them and roads and trucks to take goods to the ports. This increased wealth also enables more people to buy new cars and homes.
All of these things increase the demand for oil and gas at a time when it is more difficult and expensive to find new oil. The oil price will rise steadily as a result. That’s why it makes sense to have some exposure to the oil & gas sector. But you should also make sure you have some well placed non-commodity suppliers to the oil sector in your portfolio as a way to play this trend.
Let’s not forget that other ‘essential of life’ trend – the demand for food...
This demand for food is driven not only by the rising world population but also by the increasing demand for improved diets. More and more people in emerging economies want to eat more meat in place of grains. This puts even more pressure on food production. That’s because it takes much more grain to feed animals for meat than it does if people eat grain directly. And then there is the increasing use of land to grow biofuels which reduces the land area available for food.
These three factors – population, improving diets and less land available for food – combine to mean that farmers have to grow more food from less land. So you can play that trend by investing in companies that can help farmers dramatically improve crop yield from existing land.
The common factor that makes for predictable growth
Let me just explain that briefly. Yield improvement is based on two factors – crop protection and improved seeds. In fact, these two factors can be related. By that I mean that it’s possible to develop crop seeds which are not affected by crop protection products that kill pests and weeds. So the goal is to identify these long-term investment themes and the sectors that are going to benefit from them. Having done this, you look for the aspect in each that is most likely to provide predictable growth. And then find a suitable company with which to play the trend. So far we have identified generic pharmaceuticals, yield improvement for crops and high value services to the energy industry. These all have a common factor – research and development (R&D).
Companies in these three areas all need to invest heavily in R&D to develop new products. That’s the only way they can meet demanding product performance targets and stay ahead of the competition.
So then, R&D, financial strength and a global market position are three of the criteria you need to use in selecting good companies in these sectors.
In future issues of The Right Side, I will identify some of the specific R&D companies that are likely to enjoy predictable growth from each of these investment themes to add to those in generic pharmaceuticals mentioned in the 11 June issue.
Until next time,
Dr Michael Tubbs
For The Right Side
Publisher’s Recommendation: Dr Michael Tubbs is editor of Research Investments which specialises in recommending companies that invest in R&D to ensure that they have sector leading products and services. Click here to read Dr Tubb’s important June 11 issue on investing in the pharmaceutical sector, Four “Drug Trends”, One Major Investment Opportunity.
MARKET NOTES
Warren Buffett hasn’t lost his Midas touch
BY SHIVVY ARORA Warren Buffett, the world’s most legendary investor, has been in the news lately. His investment powerhouse Berkshire Hathaway (BRK) has been trading down for 8 straight days - something that’s only occurred 13 times in the past two decades.
Some commentators have been quick to say he’s losing his touch. But BRK is a hugely diversified company with a finger in many lucrative pies. This is its first quarterly loss in 8 years – a blip in a fantastic long-term track record. And it’s justifiable that the plunge in global stock markets has affected his company.
Take a look at the chart below. It shows Berkshire Hathaway’s (ticker: BRK; red line) performance for the past 3 years, versus the S&P 500 (green line). You can see BRK’s consistent outperformance of the broader market by a significant margin. Even now, it’s outdoing the S&P 500 by close to 25%.
Buffett’s Berkshire Hathaway is on a better run than the markets 
Buffett is a contrarian investor with an uncanny knack for picking high-quality stocks and running with it for the long-term. This pays off.
Berkshire shares are undervalued on a price to book value measure. The company has a strong balance sheet and diversified portfolio of businesses which should limit the downside to the shares.
BRK’s long-standing equity positions are strong. They’re the top shareholder in American Express and Wells Fargo (the fourth-largest U.S. bank). They’re also the biggest owner of Goldman Sachs, which has surged 93% since March 9, and the third-leading investor in U.S. Bancorp, which has climbed 74%.
Buffett believes in value investing. He buys companies that have steady cash flow, low gearing, autonomy and multiple sources of income. He won’t invest unless he understands exactly what the company does.
Crucially, this ‘intellectual investor’ advises that it’s always better to buy a wonderful company at a fair price than a fair company at a wonderful price.
You can’t argue with that.
The Daily Reckoning – Fatal Conceit
BY BILL BONNER London, England
Friday, 26 June 2009
Die Hard Illusions...
This just in – Ben Bernanke and Tim Geithner have rushed to Los Angeles. If they can revive an entire world economy... they told crowds... why not the ‘King of Pop?’
Fans are hopeful... but here at the Daily Reckoning we take a discouraging view of these revival efforts. We admire the achievements of science and technology; as for the works of economists and central bankers, well... we’ll wait to see how things turn out.
Yesterday, we took up the biggest illusion of the Bubble Era. We held it up to the light... and noticed:
So deeply rooted is this illusion that it will take more than a strong wind to uproot it.
We’re talking about the idea that government bureaucrats can do a better job of allocating capital than free markets. Everyone seems to believe it. They’re allowing a handful of economists – who failed the critical test; not one of them noticed the market tsunami coming last autumn – to direct the flow of trillions worth of savings. They’ve already put at risk more than $12 trillion. Right now, they’re denying the need for more ‘stimulus,’ but that is likely to change.
This figure - $12 trillion - is a lot of money. Adjusted for inflation, it is still more than twice as much as America spent in all of WWII. But it’s not just the money... it’s the future of the world economy that is at stake.
In a nutshell, the meddlers believe they can borrow their way out of debt. If you say that the key problem in America is debt, they won’t argue with you. But they think that they can overcome that problem by borrowing trillions more.
Many times have we argued that they will fail. We laugh at building dog walks... bailing out businesses that have lost their way... and paying huge bonuses to Wall Street execs. But those are just the obvious flaws. Down deeper, in the dark, corroded heart of the government economist is a fatal conceit…
Read on...
To read the Daily Reckoning in full, click here.
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