Wednesday, March 18, 2009

Industry Profitability

One of the most important determinants of whether a company makes for a good long-term investment is the industry within which it operates. We've discussed the boom and bust nature of the housing industry, the generous margins garnered by the soft-drink industry giants, and reasons why airlines make for poor long-term investments. But on the average, what do industry returns look like?

Harvard Professor Michael Porter, using data from Standard and Poor's as well as Compustat, has calculated the profitabilites of various industries over the 1992-2006 period, some of which are shown below:

Clearly, there is high variability in returns on capital by industry. Average industry ROIC in the US was calculated at 14.9% by Porter, demonstrating that some industries are clearly extremely profitable, while others destroy capital.

Does this mean you shouldn't own a company whose industry returns fall below the average ROIC? Absolutely not! Within industries, returns may also be highly variable, in the case where one or two companies have differentiated themselves or are low-cost producers that generate consistent industry-beating returns...but you may still want to stay away from the airline industry!


Enoch Ko said...

Hi Saj, do you have the original article/data by Michael Porter? I'm interested in reading it. Thank you.

Saj Karsan said...

Hi Enoch,

Unfortunately I only have a hardcopy, from the CFA Level 2 curriculum. Perhaps a search engine might tell you where to purchase a copy; I couldn't find a free version, sorry.

Anonymous said...

The article is here:

Anonymous said...

Here is the chart, securities brokers and dealers at the very top.

Enoch Ko said...

Thank you very much, Anonymous! Looks like security brokerage & dealers have got a good business there! Hmmm... perhaps I should get into that business!

Do you happen to have a PDF you can e-mail to me? My e-mail's in my profile. Thank you!

Anonymous said...

There can only be a limited number of brokers per 1000 people. New entrants will find it difficult to find new customers. The high RIOC comes from the low level of capital needed.