Prior to the Industrial Revolution, most Americans lived in self-sustaining agrarian communities. During this time, wealth was built through the growth and sale of cash crops and products like tobacco and lumber. Minerals, fish, and furs were also popular sources of income. Those who didn’t work in agriculture often made their living through skilled labor; blacksmiths and bakeries were common options.
But an industrial cotton mill in 1790 would begin to change the American way of life.
Samuel Slater built the first American cotton mill in Rhode Island, knocking off a British design and setting the industrial revolution in the young United States into motion. With the cotton mill, the speed at which cotton could be spun into yarn was greatly improved.
Seeing the value that technology could bring to industry, U.S. inventors quickly started to develop ways to produce products faster. This not only led to a change in how Americans made money, but how they lived.
With technology leading the way in product manufacturing, apprenticeships started to lose their value, and the factory worker was born. This led to a mass migration from rural communities to newly developed urban areas like New York City and Boston.
Soon, the U.S. would become the industrial capital of the world. Not only did this build the country’s wealth, but it also created massive opportunities for investors, opening the floodgates to investments in the industrials sector that would continue to evolve for decades to come.
What Are Industrial Stocks?
Industrial stocks are part of one of the longest-lived sectors in the United States and around the world. These stocks represent companies in the industrial sector, which has developed into far more than cotton mills.
Companies in today’s industrial sector focus in one or more of four main areas.
- Machinery. Without tractors, cranes, and bulldozers, you wouldn’t see city streets, high-rise buildings, or massive department stores. The companies that produce and distribute the machinery that helps to build the communities we live in are an important part of the industrial sector.
- Manufacturing. Companies in the industrial sector provide important basic materials used in manufacturing of finished goods. For example, the manufacturers of your television had to source the plastic used for the outside frame from another company. The company that provides that plastic, necessary to the manufacturing of your television, is a key part of the industrial sector.
- Construction. Industrial companies also provide the basic materials used in construction. Concrete, bricks, shingles, and electrical wires are all developed, produced, and distributed through industrial-goods companies.
- Health Care. The medical equipment used to treat patients who are sick, along with basic surgical tubing and other health care-related materials, are all part of the industrial sector.
- Defense and Aeorspace. Finally, industrial-goods companies are often active in the defense space. Various materials used in the development of new weaponry, vehicles, and other tools used in the defense industry are provided by companies in the industrial sector.
Pro tip: You can earn a free share of stock (up to a $200 value) when you open a new trading account from Robinhood. With Robinhood, you can customize your portfolio with stocks and ETFs, plus you can invest in fractional shares. Sign up for Robinhood.
Industrial Stock Pros & Cons
The industrial sector was an important part of the growth of the United States, making investors massive amounts of money in the process. Although there has been more than a century of growth in the sector, there are still plenty of opportunities.
There are benefits to investing in the industrial sector, but there are also some drawbacks to consider.
Industrial Stock Pros
There are several benefits to investing in the industrial sector. Some of the most important include:
- Easy to Read. Compared to other sectors, stocks in the industrial sector are relatively easy to read. That’s because the vast majority of these stocks cyclical, meaning they’re heavily correlated with economic growth. Therefore, when the economy is booming, industrial stocks are a great place to be. When economic conditions start to falter, it’s time to sell industrials and look into other investment options. The correlation between the industrial sector and economic performance makes it easy for beginner investors to plan entries and exits. For example, as the COVID-19 pandemic set in and the economy reacted, investors knew to sell industrial stocks. However, when an announcement was made that a coronavirus vaccine had resulted in strong clinical data, industrial stocks climbed as investors began to expect economic improvements.
- Poised for Growth. In recent years, politicians have been working to bring industrial development back to the United States. This has led to growth opportunities for key players in the industrial sector. For example, in 2018, changes were made to Section 179 of the United States tax code, allowing businesses to deduct the full cost of new equipment for a minimum of five years. This deduction bodes well for industrial stocks, especially those that have centered their business around the provision of equipment to companies in the construction, manufacturing, and defense sectors. After all, the changes to the tax code makes purchases from these industrial companies complete tax write-offs for other businesses. Ultimately, this makes it easy to find high-growth stocks in the sector.
- A Long History. Most of the big players in the industrial sector have a long history in business — many of them are decades or even more than a century old. Investing in companies that have been around a long while gives investors an opportunity to analyze the company from a historical perspective. If a company has created consistent growth for the past 70 or 80 years, there’s a good chance continued growth is ahead.
- Dividend Payments. The industrial sector is home to many dividend-paying stocks. When compared to the average 3.6% dividend yield seen in utilities, the average 1.76% dividend yield among industrial stocks seems quite low. However, there are many gems across the sector that pay dividend yields of 3% or more, giving you a way to earn income through dividend stocks while gaining exposure to the sector.
Industrial Stock Cons
Although there are plenty of benefits to investing in industrial stocks, the sector also comes with its fair share of drawbacks. Some of the most pressing cons to consider include:
- Economic Dependence. The fact that industrial stocks are heavily correlated with the economy makes them easy to read, but it also opens investors in these stocks up to an additional level of risk. For the buy-and-hold investor who doesn’t keep their finger on the pulse of the market, investing in the highly cyclical industrial sector could lead to painful declines when economic conditions falter or negative economic news hits.
- Low Dividends. Throughout history, the industrial sector has underperformed the wider market in terms of dividend yields. While there are a few diamonds in the rough, if you’re looking for strong dividend stocks, you’ll have to do a bit more research to find them than you would in a sector like utilities.
- Political Risk. As mentioned above, industrial stocks are currently benefiting from a positive political climate. However, the winds of political change can turn in another direction quickly. Should politicians decide to enact tax codes that aren’t as favorable to the sector as the recent changes have been, industrial companies may see dramatic sales declines and tax increases, ultimately having a negative effect on cash flows and investor returns.
What to Look for in Industrial Stocks
As with any sector, not all industrial stocks are created equal. Making money in the industrial sector depends heavily on making the right investment decisions. When looking for industrial stocks to invest in, the companies that you should consider fall into the following categories:
1. Companies With a Solid History of Growth
The industrial sector is one of the oldest sectors in the world. That gives investors the benefit of having very old companies to choose from that provide a detailed history of where they’ve been and the growth — or lack thereof — they have experienced.
When looking for investment opportunities in the industrial sector, you’re generally giving up high dividend yields in exchange for growth. So, it’s important to look for signals that the stocks in the sector you’re interested in represent solid growth stocks. Looking back at long-term stock charts, you may see dips here and there when economic recessions and depressions took hold in the United States, but you should only invest in industrial stocks that have generated significant long-run gains overall.
Also, take some time to dive into the company’s financial history. After all, when looking for industrial stocks or any other flavor of stock, a history of revenue and earnings growth is a great sign for the future.
2. Companies That Pay Dividends
The industrial sector isn’t one that’s known for great dividends. That doesn’t mean good dividends are impossible to come by. For example, Boeing — one of the larger players in the industrial sector — has consistently offered a strong dividend yield and raised its dividend payout year over year for several consecutive years.
Boeing isn’t the only company in the industrial sector that pays decent dividends. ABB, United Technologies, Lockheed Martin, and several others are known for paying strong dividends. So, if you invest in the sector, don’t rob yourself of income; look for strong dividend yields.
3. Companies With Less Exposure to the Economy
The industrial sector is heavily correlated with economic performance. When economic conditions are positive, industrial stocks go into a bull market. On the other hand, when economic conditions falter, a bear market is ahead for the industrial sector. Of course, the U.S. and global economies don’t always perform well. When picking stocks in the industrial sector, it’s best to look for companies that break the mold with weaker correlations to the broader economy than the sector as a whole.
Some kinds of industrial companies are shielded from the relatively cyclical nature of the sector:
- Defense and Aerospace. Several companies in the industrial sector either only serve defense clients or center the vast majority of their business around servicing the defense and aerospace industry. These companies are generally shielded from the impact of negative economic conditions. After all, regardless of economic conditions, the U.S. must defend itself and its interests, and it will likely continue spending massive amounts of money to do so, helping these companies maintain strong valuations during tough economic times. As such, industrial stocks with a focus on defense provide exposure to the industrial sector while weakening the economic risk associated with investing in a cyclical sector.
- Medical Manufacturing Equipment. Like defense, medicine is a subsector that will always fill a need, and thus is less dependent on positive economic conditions. Industrial companies that provide medical manufacturing equipment and other raw materials to the health care industry are generally shielded from an economic downturn, making them a great place to start your search for investment opportunities.
- Diversified Companies. Diversification is a great hedge against hardship in any space. For example, defense companies will feel pain if they lose funding for their projects or if the government decides that it no longer wants to be a customer. However, some companies in the industrial space are heavily diversified. For example, Boeing is a major defense and aerospace industrial play. However, the company also takes part in various sectors outside of defense, assisting in the development of spacecraft, electrical equipment, and clean energy resources, shielding investors from risk associated with the loss of government spending on the company’s products.
How Much Should You Invest in Industrial Stocks?
There are few investors who can get away with investing 100% of their funds in a single stock, sector, or investment vehicle. For the vast majority, diversification is key to success in the stock market.
If you had all of your money in industrial stocks and the economy took a nosedive, you would face significant losses as a result of the sector’s cyclical nature. These types of painful occurrences are exactly what diversification was designed to prevent you from experiencing.
So, how much of your portfolio should be invested in the industrial sector?
There is no one-size-fits-all answer to any diversification question. Several factors should be taken into consideration when deciding how much of your portfolio should be allocated to the industrial sector:
1. Your Exposure to Stocks
You should never have 100% of your investment portfolio exposed to the whims of stocks, exchange-traded funds (ETFs), or mutual funds. Most financial advisors suggest that a significant portion of your portfolio be invested in safer investment vehicles like bonds.
The amount of your portfolio that should be in bonds depends on your appetite for risk, your age, and your financial goals. However, if you’re not sure where to start, consider using your age to determine the percentage of your investable assets that go in bonds. That way you have a moderately diversified portfolio, at least from an asset class perspective.
For example, if you’re 28 years old and you have $10,000 to invest, you might target investing 28% ($2,800) of your overall investment portfolio in bonds to provide you with adequate protection from large swings in the value of stocks. As a result, only 72% of your portfolio value is available for stock investing, which should play into your decision of what percentage to allocate to the industrial sector specifically.
Pro tip: If you’re going to add industrial stocks to your portfolio, make sure you choose the best possible companies. Stock screeners can help you narrow down the choices to companies that meet your requirements. Learn more about our favorite stock screeners.
2. Your Investment Style
Your investment style will also play a major role here. For example, if you’re a dividend investor, you’ll likely want little exposure to the industrial sector because there just aren’t many companies in the space that are known for high dividend yields.
On the other hand, if you’re looking for strong long-run growth stocks, the industrial sector may be the perfect fit, especially when economic conditions are positive. Stocks in the space are known for strong growth during positive economic conditions.
It’s also worth noting that growth stocks like those found in the industrial sector are known to experience higher levels of volatility than stable dividend stocks. Volatility is synonymous with risk in the stock market, so industrial stocks – especially small industrial companies with a market capitalization of under $2 billion – may not be best for beginner investors.
3. The 5% Rule
Finally, the number of companies in the industrial sector that you’re interested in will play a role in the total amount of exposure you have to the sector, especially if you’re a novice investor. That’s because, unless you’re an investing guru, you should follow the 5% rule.
The rule suggests that you should never have more than 5% of your total investing dollars tied up in a single stock or across a group of high-risk stock picks. So if you’re looking at three industrial stocks, and you believe all of them are top-notch investing opportunities, you could invest up to 5% of your portfolio into each company — so your entire allocation to these stocks would be no more than 15% of your portfolio. If your picks are penny stocks that come with other factors that involve high risk, then together they should represent no more than 5% of your overall portfolio value combined.
The industrial sector isn’t just important to the stock market, it’s an important part of American history. The sector has created millionaires while giving rise to urban development, employment opportunity, and global economic dominance in the United States.
No wonder so many people want to invest in industrial stocks!
Making the right moves with industrial stocks can result in dramatic gains that even famed investor Warren Buffett wouldn’t ignore. On the other hand, making the wrong investments in industrial stocks can cost you.
Before you invest in the space, make sure that the stock you’re interested in is heavily diversified, is shielded from risks associated with the cyclical nature of the industrial sector, provides investors with a compelling dividend yield, or offers a mix of these three conditions. Also, take a moment to consider the state of the United States and global economies as well as the political environment when planning an entrance into or exit out of any cyclical stocks, including industrial stocks.
Finally, always invest responsibly. If you’re not sure you’re making the right decision in the stock market, don’t make it. Instead, take the time to do your research or consider speaking with a financial advisor before investing in industrial stocks or any other sector. An educated investment always has better odds of being a winning investment.