In contrast to the consumer goods sector that produces goods and services directly consumed by households, the industrial goods sector provides capital goods to other businesses for manufacturing and construction. The sub-sectors include aerospace and defense, homebuilding, electric equipment, machinery, construction and engineering, distributors, etc.
The industrial goods sector is sensitive to economic cycles. The sector’s performance is mainly driven by the demand for residential, commercial, and industrial construction. The economic activity level in such areas declines significantly during recessions, reducing the demand for industrial goods.
However, with a wide range of sub-sectors, not all businesses in the sector slow down their production simultaneously. Some sub-sectors may lag, while some may lead the economic cycles. Waste management companies and industrial conglomerates often demonstrate resilience. They are able to generate relatively steady revenue streams during economic downturns.
The industrial goods sector consists of the companies that produce and sell capital goods to other businesses. Most businesses in the industrial goods sector are sensitive to the economic cycle.
The industrial goods sector has high barriers of entry due to large capital investments and cost-saving from economies of scale.
The Industrial Production Index (IPI) and capitalization utilization rate can be used to measure the performance of the industrial goods sector.
Businesses in the Industrial Goods Sector
Given the nature of industrial goods production, this sector has high barriers to entry with large capital requirements. Economies of scale also play an important role in cost-saving. Thus, some of the largest companies in the world are from the industrial goods sector.
CNH Industrial is an American and Italian multinational corporation in the automotive industry. It produces agricultural and construction equipment, industrial powertrains, trucks, buses, and other commercial vehicles. The company employs more than 60,000 individuals and operates 37 manufacturing facilities around the world.
Another example is Michelin, a French multinational tire producer. As the world’s largest tire maker, it oversees 69 manufacturing facilities in 17 countries in Europe, Asia, and North America.
Industrial goods businesses typically hold large amounts of fixed assets. This is from their large manufacturing facilities and equipment.
Performance Measurement of the Industrial Goods Sector
The Industrial Production Index (IPI) can be used to evaluate and forecast the health of the industrial sector. It is a macroeconomic indicator updated every month. The index measures the production level of the manufacturing, mining, and utility sectors. Compared to GDP, IPI is a more reliable estimate of the performance of the industrial sector. It excludes the value-adds from retailers.
The capacity utilization rate can be generated based on IPI. It measures the strength of demand relative to supply. Low capacity utilization (“overcapacity”) of industrial outputs represents weak demand. This is a negative signal to the industrial goods sector. High capacity utilization indicates strong demand and positive momentum in the sector.
There are also stock indices that measure the equity performance of industrial businesses. The Dow Jones Industrial Average (DJIA) consists of the thirty largest companies in the US. Yet, it is often criticized for its narrow coverage and price-weighted average.
The Nasdaq Industrial Index (INDS) covers the Nasdaq-listed companies that are involved in energy production, equipment production, chemicals, construction and materials, general industrials, and so on. It is worth noting that not all the companies covered by the indices perform in the industrial goods sector. Many of them are from a broader category.
Investment in the Industrial Goods Sector
The industrial goods sector demonstrates a high correlation with the macroeconomic environment. Thus, investors can ride on the economic growth through exposure in this sector. Retail investors can buy publicly issued bonds and stocks of industrial goods companies. Institutional investors with abundant capital can also involve in private equity deals.
Most of the industrial goods companies are at the maturity stage, especially the publicly issued ones. They usually make consistent dividend distributions to the shareholders. Investors also need to consider their asset allocation to the industrial goods sector. They can manage the sensitivity of their portfolios to the economic cycle through exposure to defensive sectors.
CFI offers the Capital Markets & Securities Analyst (CMSA)® certification program for those looking to take their careers to the next level. To keep learning and advance your career, the following resources will be helpful: