Industries Beating Cost of Capital

Many people still can’t digest why the industry is more important than business or company

There is a quote of Charlie Munger, that is “Fish where the fish are”, means that if you have a pond with a high number of good fishes, why will you go for another one which has hardly few good fishes

That means, if you have a good industry in which every average company is earning decent profits, then why do you want to go for an industry which hardly has a few successful companies

By only identifying a good sector you become a 50% successful investor because the probability of choosing the right company becomes high there

Industry analysis is analyzing an industry which has more companies with modest performance

If you are successful at picking the right industry, your probability of picking correct and high-performance stock will increase

Hence, industry analysis is the biggest and most important filter for your portfolio

How can we do industry analysis?

It requires a lot of time do to, but by doing it, you are spending your time in the right place

Here we are with our industry analysis, in which we have India’s around 80 industries and its companies

Positive Economic Profit

We have used the company’s 10-year ROCE i.e. return on capital invested, which interprets how much profit the company have made on its total capital i.e. equity + borrowings

ROCE = (EBIT * (1-T)) / (Equity + debt)

Where,

            EBIT = Earnings Before Interest and Tax

            T = Tax rate

            Equity = shareholder’s equity + reserves

            Debt = Long-term borrowing + Short-term borrowing + Current portion of long-term borrowing

(In this analysis, ROIC – Return on Invested Capital – can be a better measure and can show a truer picture of a company’s growth and performance, but yet ROCE can give a broader picture of industries’ long-term performance)

We need Economic profit – which is how much the company has made over and above its cost of capital – for our analysis because a company who can consistently – for 10-years – make returns above the cost of capital, company is worth investing

For how much the company has made, we have 10-year ROCE data, and to reach economic profit, we need the cost of capital

As we present in Opportunity Cost Model, every Indian business have a cost of capital of 13% – which is a nifty 10-year average rolling return

We deduct COC/opportunity cost of 13% from companies’ ROCE, and we are done with all companies’ 10-year average economic profit

But companies work on different capital, hence they have different weight in their own industry

Hence, we count the company’s weighted average economic profit to come to at better conclusion and analysis

Industry analysis chart

Industry analysis chart

The main objective of this analysis is to select a pond which has a high number of good fishes at stated earlier

Hence from this chart, you can select an industry who have companies with consistent economic profit, i.e. companies with a consistent return above the cost of capital or opportunity cost

(As the main analysis, we have taken weights of the company according to their total capital which is equity + debt, but in excel file, you will get weights of companies according to their total assets also;

moreover, we have compared the economic profit chart with those industries average 10-year share price CAGR chart to conclude better)

Excel file:

industry-analysis

This excel file contains all the data on which we have conducted the analysis

You will get industry-wise and company-wise all important data for the long-term analysis

Published by Aakash and Meet

I am Aakash Raotole I am currently doing Bcom from Dr. Patel and Rb Patel commerce college I am currently studying at finnacle investment academy Recently done distance internship with windrose capital, Pune - for a period of 14 weeks I am Meet Bhatt Completed HSC in commerce Now studying finbridge program at finnacle investment academy and Bcom externals I had completed CFA institute's investment foundation course and distance internship with Windrose capital, Pune - for a period of 14 weeks

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