Investor sentiment towards some sectors has improved significantly over the past few years. For example, firms focused on artificial intelligence, automation and sustainable technologies including electric vehicles have become increasingly popular.
In the long run, those industries and others could deliver high levels of growth and profit. However, investors seeking to capitalize on them may find the task more difficult than it initially appears. For example, it can be difficult to identify which companies will be able to take advantage of growing demand. That task is made more challenging when there are a wide range of stocks available for investors to buy.
In addition, technology can quickly change. Firms that appear to be at the forefront of technological change may be superseded by other businesses with new operating methods or products.
Buffett's views
The difficulty of investing in growth industries was highlighted by Warren Buffett (Trades, Portfolio) at the 2021 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) shareholders meeting. He discussed the automotive industry's vast potential at the turn of the 20th century and how investing in it proved to be very challenging. He said:
"There were at least 2000 companies that entered the auto business because it clearly had this incredible future. And of course you remember that in 2009, there were three left, two of which went bankrupt. So there was a lot more to picking stocks than figuring out what's going to be a wonderful industry in the future."
In my view, Buffett's points are highly relevant to investors today. Industries such as technology appear to have excellent growth prospects. However, the recent rise in their valuations means that it may now be tough to identify stocks offering wide margins of safety. This could mean that many investors obtain unfavorable risk/reward opportunities.
It may also be challenging to pick stocks that have the best chance of remaining relevant in growth industries that are very fluid. Further technological development may make it difficult for investors to identify the strongest businesses.
A prudent strategy
In my opinion, a strategy that focuses on diversification could be a sound means of allocating capital in growth sectors. Diversifying across a wide range of companies within growth industries will reduce an investor's company-specific risk. This may also increase their chances of capitalizing on future growth opportunities by holding different companies that together offer a greater chance of remaining at the forefront of technological change.
In addition, diversifying across multiple sectors could be a logical approach. This will not only reduce an investor's exposure to one sector. It can also allow them to access growth opportunities across industries that may initially appear less appealing.
For example, sectors such as energy, banking and retail may be viewed as lacking growth opportunities by some investors at the present time due to their modest earnings growth forecasts. However, lower investor demand for stocks in these industries may mean there are superior value opportunities available that produce higher long-term returns.
Buffett's views are likely to remain relevant over the long run as different sectors become popular among investors at different times. As a result, a strategy that aims to overcome the inherent difficulties in capitalizing on growth sectors could be a useful ally for many investors over the long run.
Disclosure: The author has no position in any stocks mentioned.
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