Investing: 2 Sectors to Avoid at the Moment

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Recently, I wrote an article in which I gave advice regarding the best way to pick winning sectors that you should incorporate into your portfolio. The points I made include:

  1. Pick sectors with minimal competition.
  2. Pick sectors that provide people and businesses with things that they need.
  3. Pick sectors with recurring revenues.

Given these points and given some other external factors, I have come up with similar criteria for sectors that investors should avoid. Note that they aren’t all negations of the above points:

  1. Avoid sectors with a lot of competition.
  2. Avoid sectors in which companies have large variable input costs.
  3. Avoid sectors for which you can easily point out competing sectors or companies that have a clear advantage.

If you follow this advice, you may miss out on some winning stocks — but at the same time, I think you’ll miss out on a bunch of losers.

One more point before I list the two sectors to avoid is the following. There are thousands of stocks out there, and depending on how you divide them, there are dozens, if not hundreds, of sectors. Your portfolio will be comprised of maybe five to 15 stocks and maybe three to seven sectors. In a nutshell, your portfolio is more selective than the toughest Ivy League colleges. Therefore, your first instinct should be to find reasons not to invest in a stock or a sector. Put another way, unlike in the U.S. justice system, a stock or a sector is guilty until proven innocent.

1. Grocery stores

The grocery business is incredibly competitive. Not only do grocery stores sell groceries, but convenience stores sell groceries, drug stores [e.g., CVS (NYSE:CVS)] sell groceries, discount retailers [e.g., Wal-Mart (NYSE:WMT)] sell groceries, and so on. Other than a few local chains, Whole Foods (NYSE:WFM), and Fairway (NASDAQ:FWM), grocery stores are chosen for their convenience and proximity to the consumer.

Furthermore, these companies have razor-thin profit margins, and inventory has to be diligently managed if it isn’t going to go to waste. Finally, food prices are highly volatile, and the consumer product companies and farms typically choose an item’s price. Given these points, the three points I list above are all met by grocery stores, and these stocks should be avoided. If you must have some exposure to the space, consider a company such as Wal-Mart. Better yet, step back to the actual farming process and consider fertilizer companies and agricultural machinery companies.

2. Trucking companies

Many of my complaints regarding the grocery business apply to the trucking industry. Trucking is extremely competitive, and there is little barrier to entry — any company that can put together a few trucks and hire a few drivers can start a small trucking company. Furthermore, trucking companies have to compete with boat transport, air transport, and rail transport. The latter, in particular, competes fairly head-on with the trucking industry, and it is far more efficient when it comes to labor and fuel utilization.

This brings me to my next point, which is that fuel is a high and volatile expense that goes into trucking. If the price of fuel rises substantially, the trucking company has to eat that cost. In some cases, it has clauses in its contracts with its clients that stipulate that the client is responsible for the heightened cost. But such clauses just make rail transport the better option. Only buy a trucking company if you believe that the economy will be strong and that the oil price will fall. This is an unusual combination, but it is the only one in which trucking companies come out as clear winners.

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