Someone emailed me this question:
“I enjoyed your podcast on how to research an industry. I wanted to ask whether you take different approaches when it comes to researching a mature industry versus a growing industry. I can find a good amount of information (through investor presentations and industry reports) on growing markets such as e-commerce, but I struggle to find the same depth and breadth of information for relatively mature industries such as apparel, shoes, etc."
The best source of information on an industry is usually the investor presentations of the various companies that make up that industry. The 10-Ks are also useful. However, a 10-K involves a lot of boilerplate. You need to know which parts of the 10-K – and even which specific lines – are really, really important. I will give you an example. There is a line – or sometimes a whole section – in every 10-K that will discuss the factors on which a company competes. In the competition section of the 10-K, you will find a company say something like:
"The supermarket industry is subject to intense competition and is relatively fragmented. Like most supermarkets, we primarily compete on selection, price and location. Some of the largest competitors in our market area are regional supermarket chains such as Stop & Shop, Kings and Wegman’s. In recent years, we have also experienced competitive pressure from national and specialty supermarkets such as Whole Foods (WFM, Financial) and The Fresh Market (TFM, Financial). Some of these competitors may have different business models from our own, which may present unique competitive problems for us. In certain market areas, Walmart (WMT, Financial), Target (TGT, Financial) and Costco (COST, Financial) locations sell some of the same product ranges we do. However, management believes competition with such retailers is limited."
That is not an exact quote from any 10-K, but it is very close to what you will normally read in the competition section.
At some point, there will be a boilerplate line that says some of the competitors may have greater financial resources or better name recognition. You can safely ignore this line. It is included even in 10-Ks where it is completely meaningless. There are certain other nuances of which you should be aware. In most cases, a U.S. company will overstate the intensity of competition in its industry and understate its own competitive position. This is not necessarily true in other countries.
It is important to start with an idea of what a typical, meaningless sort of “competition” section in a 10-K looks like. Once you know what the standard is, you can quickly pick out any terms that stray from that norm. For example, Nordstrom Inc. (JWN, Financial) includes “customer service” as a key competitive factor. That is unusual for a department store. Almost everyone includes “price” as a competitive factor. If you ever read a 10-K where the company does not mention the word “price," that is critically important.
It is also important if the company includes competitive factors that are in some way unusual. Most 10-Ks will not stress “credit terms” or “prompt delivery” or “order fill rates” or anything as mundane and logistical as that. There are industries where that is important.
It is also important to notice limiting factors on competition. If a supermarket says customers are generally unwilling to drive more than five to 15 minutes to shop for groceries, that is very important. The company may phrase this in a way that makes it sound like a bad thing. For example, they may say that because customers are unwilling to drive more than five to 15 minutes and it is difficult to find locations with sufficient parking, their growth may be constrained by the lack of available places to put a new supermarket. You can look at that limitation to the company’s growth and see that it is really a barrier to entry.
In some cases, the company will not make a big deal about barriers to entry in its industry. You have to judge whether the tone of the information is promotional or conservative. For instance, 10-Ks are especially vulnerable to being full of nothing but legal disclaimers that do not really mean anything. The company will often include nonmaterial risks. I have seen companies like movie theater chains include global warming, SARS and even terrorism. This is wrong. In fact, it really does not match the guidance they have been given on what is and is not a material risk. I have also seen companies that do not need access to credit include risks to the financial system. This is what makes reading 10-Ks difficult. They have a lot of nonsense in them that neither the preparer of the report nor the user of the report actually believes is in any way material. It’s just fine print that covers every possible negative occurrence the company could experience.
Obviously, the “competition” section is the most important part of a 10-K. And certain key phrases like “a limited number of competitors,” “relatively high barriers to entry” and “compete primarily on factors other than price” are the ones you want to look for. They’re rare. I’ve seen 10-Ks where even long established duopolies or oligopolies won’t really come out and say competition in the industry is limited and market entry has been unheard of for decades. One of the giveaways that an industry is very consolidated will be the company’s willingness to list essentially all of its competitors in the 10-K. Hanesbrands (HBI, Financial) may actually come out and say we compete with Fruit of the Loom and other lesser-known brands. Or Energizer may say we compete with Duracell, Rayovac and other lesser-known brands. The most useful information is when a company gives information about market share, actual brand names and competitive strategy of either itself or its competitors. For example, a company may describe pricing positions in the 10-K saying that Energizer and Duracell compete on factors besides merely price while Rayovac openly positions itself as a “value” brand with performance similar to the leading brand and a lower price.
There will also be some talk of distribution. This is critically important. You want to know who sells a company’s products. The seller of the product is going to be a key source of industry information. It’s very important to know if Sherwin-Williams (SHW, Financial) is sold mostly through Sherwin-Williams stores or through places like Home Depot (HD, Financial).
The most useful report you will ever find is the presentation that accompanied a company’s going public – or being spun off – in the first place. Always go to EDGAR and search for an “S-1” or something similar. I always go back in time to find the very first filings a company ever had. It doesn’t matter if this information is from the company you’re interested in or a competitor. In both cases, it will be useful. The reason this document is so helpful is that it often explains the business model and the industry structure to analysts who might not otherwise understand what to expect from the company.
To give you an idea of how boring and mature an industry can be and still provide useful information, I read a pretty good investor presentation on the school bus manufacturing industry in North America and another pretty good investor presentation on the potato processing (like french fries, tater tots, etc.) industry. In both cases, a newly public company decided to devote a lot of its presentation to explaining an industry that might otherwise be obscure. Actually, industries no one knows anything about often have good information.
The problem is usually when you are analyzing a company that does something very specific in a big industry group. Aerospace is a good example. IT is another good example. There are tons of analysts that cover these industry groups. If you find a company that makes some specific part, it may be hard to find much out about that part.
When Quan, my newsletter co-writer, and I were writing the newsletter, we picked a company called Breeze-Eastern (now private). It made rescue hoists for helicopters. The helicopter industry is huge, but most helicopters aren’t involved in search and rescue operations. You can find a ton of information about companies that supply helicopters to NATO militaries and even some information about helicopters used to fly people back and forth from onshore and offshore locations. But, there isn’t any discussion of search and rescue hoists. We had to find decision makers who had something to do with the actual training of search and rescue crews to understand the industry.
We didn’t have a great understanding of Breeze-Eastern until we were able to find contact information for something like state police, firefighters, etc. We didn’t pick Q-Logic (no longer public). We would have had a similar problem with Q-Logic. That company makes what is essentially a small part of big projects. It was easy to find information on the end customer and on the companies that provided the overall setup. It was more difficult to find information on the reasons why a company would choose to use Q-Logic’s product or a competitor’s product. The most difficult part in that case was understanding technological change. We were able to gather enough information to understand Q-Logic’s competitive position provided everyone always chose to do something a certain way. If some larger scale decisions were made differently, we had a hard time knowing what that meant for Q-Logic. It was a small part of a big ecosystem.
I would suggest reading all the 10-Ks and investor presentations and especially the initial filing documents for every company in a mature industry you are interested in. My next suggestions would be to try to find the customers of this industry. If you are interested in apparel or shoes, can you find the wholesalers or the retailers who buy these products? What do they say about their suppliers? Do they list their largest supplier? Do they talk about their dependency on these suppliers? Can you find people inside these companies – buyers – to talk to? People are always happy to tell you about what they do and why they do it. I get emails from individual investors all the time who ask: “how can you get people to talk to you?” If you find people who make the decisions to buy Stressless recliners or Hunter Douglas (XAMS:HDG, Financial) blinds for their store or carry Progressive insurance at their agency or outfit the department’s six helicopters with Breeze-Eastern rescue hoists, they will be very, very happy to tell you exactly why they made the decisions they made. They’ll volunteer information about their contacts at the supplier company and whether who tends to call the other and how often they talk and whether the suppliers are better or worse than the last guys were and all that stuff.
The same is true, by the way, of branch managers for any kind of store. Store managers are always eager to tell you what corporate is doing right and what it’s doing wrong and who the easiest customers are to sell to and who the hardest are. If they’ve worked at more than one location, they’ll be happy to tell you why it was easy to run location and hard to run the other one. Remember, no one outside of the company ever asks this person about what they do all day. A store manager’s husband may ask her what her day was like. But, even he’s not really going to ask which kind of customer is best and how easy or hard it is to retain good entry-level people and all that sort of stuff. I mean, we did a newsletter on Grainger (GWW, Financial) and on MSC Industrial (MSM). I’m sure the plant manager of a machine shop that uses MSC has never talked to anyone outside the company about why he made that decision. He’ll be happy to get a chance to talk to you about it.
A lot of investors who haven’t tried what Phil Fisher called the “scuttlebutt” approach have trouble believing this. Why will someone tell you about their job? Why will they tell you what their company is doing right, what it’s doing wrong, who the best competitor is, what competitors are better at, what their company is better at, etc.? It’s what they do all day and no one talks to them about it. People like talking about themselves and their jobs. If you seem informed, interested and nonjudgmental, they’ll tell you lots of stuff. Some people won’t. Generally, people at bigger companies and more visible companies won’t talk as much to you. Some people will refer any contact you attempt with them to investor relations.
I only have a few specific hints to offer. One is to read Fisher’s writings. Another bit of advice is to always tell any contact you make that under no circumstances will you short the stock (this is always true for me so I don’t mind promising it) and that you will never reveal the source of your information. Also, it’s a very good idea to demonstrate your knowledge of the industry, the company and even the job of the person you are talking to right off the bat. You can use sites like Glassdoor, ads for open positions at the company, and self-descriptions (on social media, etc.) by employees and especially ex-employees of what their position entailed. The more someone thinks you know ahead of time, the more they’ll tell you things you want to know.
You’ll also find this tip from Fisher. He mentions not talking to top management until you’re nearly done with all your other research. I agree with that. There’s little use in talking to people high up in an organization until you know a lot about the company already. The more you know before going into an interview, the more you’ll get out of that interview.
Personally, I don’t find it helpful to talk to top management. And I’ve learned how to do the kind of research you get out of the “scuttlebutt” approach without actually doing it. I’ve heard Warren Buffett (Trades, Portfolio) say something similar. He did a lot of scuttlebutt in the past but now gets enough of the same info just from the way he’s learned to interpret the publicly available documents, etc. That’s very true. The more scuttlebutt you do, the more you find you don’t really need to do scuttlebutt if you just learn to read between the lines more than most investors, analysts, etc., do. Almost all the facts that matter are right there in earnings calls, 10-Ks, investor presentations, interviews with the CEO, etc. You just have to do a lot more inferring than most investors do.
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