• Saahil Menon

New Investors: The Optimal Sectors To Target and Why

Updated: Oct 29, 2019

New investors come in many characters: risky, conservative, ambitious, relaxed etc. etc. While we've mentioned that Index Funds are generally the most convenient investment for any investor, there are always some individuals who want to go a step further: take on a little more risk for a tad greater reward.

This article is meant for those who want to leverage the sweet spot between index fund investing and full-on equities investing: an area that can still prove rewarding if done correctly.

If you have the time to do a little bit of research and educate yourself, yet prefer not to spend several hours analyzing companies, you should be targeting certain industries that exude high returns at lower levels of risk, which is supremely the purpose of this article.

Without any further ado, here are the 3 sectors to optimally target and profit in, all from the comfort of your home.

1. The FinTech Sector

At the time of writing, this industry is right around the point of maturity: we'll be seeing more growth, just not at the same expedited levels as before.

FinTech stocks were rapidly chasing 50-100% growth in one year at a recent point in time, but we're now seeing other industries, such as marijuana and artificial intelligence, taking away that flare. Currently, the FinTech industry is still growing because of countless new companies arising, but it’s certainly been increasing at a lowered rate in the past few quarters. From here, we can imply that the movement within this industry is now more relaxed: at a stable and less-rigorous pace, both of which suggest that it’s the financial sweet spot for those looking to enter the investing realm.

Figure 1: FinTech Industry Investment Growth:

As shown above, global investment into fintech’s have been steadily augmenting as the years go on, with funding in 2018 being over double the amount in 2017.

These tempestuous growth levels depict the market's hype and excitement for fintech prospects, and shows investors that their profits won't remain stagnant in this market. While the rapid growth in the figure may suggest that FinTech's are still overhyped, 2019 results will contradict that assertion. So far, there has been a 20%+ decrease in global investments for FinTech firms, which implies that the hype is slowly deteriorating and we'll be seeing companies priced at levels that reflect their fundamentals more closely instead: i.e. we'll be seeing more reliable opportunities here. A clear substantiation of this can be seen by comparing Price/Earnings ratios over time:

A Price/Earnings calculation determines the ratio between the price of the stock and its earnings per share (e.g. Apple's stock price of $246.58 divided by its EPS of $11.74 = P/E Ratio of 21.01).

Ideally, according to legendary financier Ben Graham, we want to be seeing a stock price of 20-30 times its EPS, with anything above 40 or 50 being a cause for concern.

While we don't have such favorable ratios in the Fintech sector yet, there has been stellar improvement within the last year or so. To depict the level of P/E improvement, consider the fact that in early 2018, we saw Square Inc.’s and Wirecard P/E ratios trading at a whopping 940 times the EPS for the former, and 76 times for the latter.

These were two of the biggest players in FinTech, but their P/E ratios suggested that these stocks were hugely overhyped and therefore, greatly overvalued: share prices superseded their earnings by simply far too much. It’s significant to deduce this because usually companies with P/E ratios as extensive as these have assets that cannot substantiate such a high stock price: implying that eventually, they will go bust.

The point to ingrain here is, while they sustained ridiculous valuations several years ago, these companies are now trading at multiples of 104 and 31 respectively: an improvement of over 100% on each side (shown below). This depicts that the sense of overhype has ceased and that they’re beginning to trade much closer to their true valuation: both of which create the impression of a more stabilized industry.

Figure 2: P/E Ratio Comparison of Square Inc. (Left) and Wirecard (Right)

Source: (Macrotrends and YCharts, 2019)

This is one of the few times in basic investing whereby a downward sloping graph over time is actually a positive thing. The P/E ratios of these companies have been shown to greatly reduce and therefore provide more reliable prices with regard to their Earnings Per Share: an extremely positive result for analysts looking to judge these stocks.

The fact that the P/E ratios of FinTech players are reducing should show potential incomers that this industry is still growing but at a rate that’s quite stable and far less volatile than it previously was. As a result, new investors who are eager for some high returns can expect some favorable picks in this industry, with volatility and risk levels that are tolerable for those new to the game.

2. The Airline Sector

While Boeing, a prominent player in this industry, and Thomas Cook are currently taking a colossal beating for their indiscretions, this is generally a stable sector to invest in and has provided investors with consistently solid returns over time.

This is because air travel is a service that almost all individuals use as a medium of transport between countries: it's highly price inelastic and is likely to remain that way for the foreseeable future. Inelasticity is significant to consider as it suggests that aviation will be used regardless of economic sentiment, and therefore implies that airliners will obtain consistent earnings: both of which articulate the favorability of this industry for new investors.

Moreover, Aviation contributes to $2.7 trillion of the world’s GDP (3.6%), which undoubtedly reflects its necessity to consumers and also substantiates the level of profitability that it provides year-on-year. In fact, aviation profits have been increasing continually for 10 years, therefore depicting the reliability of this sector as well as it's comparatively lower volatility: both key points to consider when making an investment.

Figure 3: Year-On-Year Growth in Revenues of the Airline Industry

Source: Forbes

Thus, looking into the big players of the aviation industry would be a beneficial place to start when considering your core portfolio. Incredible cash reserves, year-round demand, and consistent profitability for over a decade. What could be better?

Key Point: It’s critical to remember that each of the industries mentioned today should only be parts of your portfolio: the entirety of your capital shouldn't be in a single sector.

Even clueless individuals in finance know that the sole rule in this community is diversification: you must spread your risk under any circumstances. Financially shield yourself from market volatility by building income streams from different industries: when one sector plummets, ensure that you're still profiting from another.

3. The Technology Sector

Our first and second industries are your low-to-medium risk sectors: the reliable few that you can be holding in order to avoid high volatility and still benefit from growth . The technology industry, however, holds a pervasive range of companies, and this is where you face the trade-off between higher risk and reward.

While our current economy greatly benefits from the advent of technology, it’s no secret that this industry still attains the potential to exponentially grow: i.e. here's your reward. In the same way that nobody knew we would need a 5.5 inch phone that does everything for us, there are countless products we may think we don’t need now, but will strongly demand in the future. However, with the millions of tech companies out there, how do we know which ones will survive? I.e. how do we cap our risk?

The sad truth is that nobody - not even Warren Buffet, Ray Dalio, or good old Bobby Axelrod - would know which companies survive and which don't. This is why holding Blue Chip technology stocks in your core portfolio is perhaps the smartest choice: invest in companies that can benefit from technology growth, obtain vast profitability, and survive any potential shakedowns in almost all economic environments.

To give an example of the difference in performance between a blue chip and a regular growth stock, consider the diagrams below, comparing the performance of Alphabet Inc. (Google) and Advanced Micro Devices (AMD):

Figure 4: Stock Price Volatility Comparison

Source: (Google Finance, 2019)

As you can see on the left, the established, financially adept blue chip has limited volatility over is life cycle as a publicly traded company, whereas the AMD stock behavior doesn’t reflect this level of consistency. Even though the timelines are differing (i.e. Alphabet/Google’s stock only starts in 2004 and AMD’s starts in 1972), if you look at both companies’ performances since 2007, the latter is unequivocally far more volatile.

This is all to articulate the fact that new investors should refrain from placing volatile/growth/risky stocks in their core portfolio, and should instead focus on more reliable tech companies such as Google instead. The tech sector already carries so much uncertainty, so the optimal way to limit this riskiness is investing in strong companies: forego soaring profits from overhyped companies so that you can avoid the punishment when they inevitably go bust.

To Recap:

  • The FinTech sector is beginning to look like a stable industry, but still holds growth prospects simultaneously. This is implied through the lowered P/E ratios of FinTech companies over time, and the fact that more consumers are moving towards digital payment systems as the years go on, respectively.

  • The Airline sector is one of the largest business contributors to the world’s GDP, as millions of individuals use aviation as a medium of transport on a daily basis. This facilitates an unmatched level of consistency, which is substantiated by the sector producing profits for 10 continuous years. The stability of this sector (most of the time) is what makes it suitable for a place in a new investor’s portfolio.

  • The Technology sector is almost always posed for growth, due to new inventions every year. Many companies enter this industry each year, and they tend to easily get overhyped: a level of risk that may be unsuitable for new investors. However, focusing on the established, Blue Chip companies in this industry will allow investors to ride the growth train whilst still sustaining a lower level of volatility: both of which are why big Technology companies are a profitable endeavor for the new investor.

Overall, remember that no stock should be bought at full price: in the same way that you purchase luxuries on discount, company shares are no different. Wait for the plummeting, and only then feast on these industries with the cash you've kept aside!