It’s been widely quoted that in investing, just like in fishing, choosing the right pond to fish in can be more important than the skill and the equipment possessed by the fish man. If you are a skillful fish man with best in class equipment and you choose the right pond, you will have wonderful results. In investing, this is when skill, experiences and circle of competency meet the “strike zone.”
In the past two years or so, I have noticed a pattern among a few outstanding investors. For instance, Tom Russo (Trades, Portfolio) has historically had an overwhelming overweight to consumer staples; Don Yacktman’s investments have been mainly in consumer staples and entertainment; Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) have historically heavily invested in financials, just like Bruce Berkowitz. One of Vanguard’s most successful funds is the Vanguard Health Care Fund, which has crushed the S&P 500 in any given five-year and 10-year period.
Out of curiosity, I did research on the sector returns from 1974 to 2015. While I’m sure I can probably go back further to get a larger sample, I think 42 years is long enough to draw some preliminary conclusions.
Here is a snapshot of my data collection (sector return data is from a Goldman Sachs report):
There are a lot of interesting data points, for instance:
- Health care, consumer staples, financials and energy have the highest “batting average” in terms of beating the index.
- Materials and industrials have the worst “batting average.”
- The longest winning streak and losing streak occur during the same period of time - consumer staples had an eight consecutive outperformance between 1984 and 1991 and industrials had an eight-year losing streak during the same period.
- Prior to the 2008 to 2009 financial crisis, the financial sector had a stellar performance.
- The energy sector, while it has one of the best “betting averages,” is unbelievably volatile.
Is it coincidence that the materials and industrials sectors have historically trailed by the health care and consumer staples sectors by a large margin? I doubt it.
Companies in materials and industrials sectors tend to have very high capex and low return on tangible capital. Worse yet, very often the products and services are undifferentiated and are hugely cyclical. On the other hand, companies in healthcare and consumer staple sectors tend to have low capex need, high return on tangible capital and they often offer differentiated products or services with powerful brand names attached. The health care and consumer staples sectors are often said to be “recession proof.”
Now perhaps we can guess that the aforementioned gurus concentrate their investments in the sectors with “higher batting averages” for a good reason as we have seen from our mini research adventure. This is not a top-down call and I’m not saying everyone should invest only in the health care and consumer staples sectors. It just seems easier to tip the odds in your favor as opposed to bucking the trend. There are legitimate ways to make a lot of money in industrial and materials companies (low return high capex businesses tend to be ugly and cheap). Of course it all boils down to the price you pay in relation to the value you get. The current valuation level for many great companies in health care and consumer staples is a little frothy in my opinion.
Maybe we can draw the following conclusion based on the discussion above: A wise fishman spends more time studying the potential ponds with the highest density of fish and upgrading his equipment and skillset accordingly.
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