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 a 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.
- Defense. 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.
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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 are heavily correlated with the economy. 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.
- Poised for Growth. Recently, 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.
- A Long History. Most of the big players in the industrial space 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.
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 industrial sector could lead to painful declines when economic conditions falter.
- Low Dividends. Throughout history, the industrial sector has underperformed the wider market in terms of dividends. While there are a few diamonds in the rough, if you’re looking for strong dividend plays, this sector isn’t likely the one for you.
- 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 declines in sales, ultimately having a negative effect on investor returns.
What to Look for in Industrial Stocks
As with any sector, not all industrial stocks are created equal. Making money in the 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, it’s best to look for companies that have a solid history of growth. Looking back at long-term stock charts, you may see dips here and there when economic recessions and depressions took hold, but you should only invest in industrial stocks that have generated significant long-run gains overall.
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 paid dividends 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, Caterpillar, 3M, 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 payers.
3. Companies With Less Exposure to the Economy
The industrial sector is heavily correlated with economic performance. Of course, the U.S. and global economies don’t always perform well. When picking stocks in the industrial space, 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 that are shielded from economic correlation include:
- Defense. Several companies in the industrial sector either only serve defense clients or center the vast majority of their business around servicing the defense 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. As such, industrial stocks with a focus on defense provide exposure to the industrial sector while weakening the economic risk associated with investing in the sector.
- Medical Manufacturing Equipment. Like defense, medicine is an area 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 medical space 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 industrial play. However, the company also takes part in various sectors outside of defense, 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. 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 that 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 the stock market. 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.
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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 plays, 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.
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 five-percent 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 the space!
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 economic risk, 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 or exit.
Finally, always invest responsibly. If you’re not sure you’re making the right decision, 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.
Do you invest in the industrial sector? What are your favorite industrial stocks?