Why shun capital-intensive industries?
One of the things I have not yet figured out is why so many successful value investors seem to avoid industries with heavy capital expenditure requirements. There seems to be something intrinsically bad about such industries, yet I cannot figure it out.
My understanding is that free cash flow analysis is done to look beyond GAAP earnings, and get a handle on the true nature of the business. If successful, the analyst will then know whether or not a company will generate wealth over the long term.
OK, so this is an acknowledgement not to take GAAP at face value, but rather to use it as a consistent starting point, and apply intelligent and insightful analysis from there.
So let's say you are analyzing an industry such as beer or steel. My understanding is that they are capital intensive commodity businesses in a mature (or possibly shrinking) market.
(As an aside, if the depreciation schedules mandated by GAAP are reasonably close to reality, and the company is neither growing nor shrinking, wouldn't the capital expenditures closely approximate the D&A charges? (taking into account inflation, etc). In other words, shouldn't GAAP earnings in fact be a reasonably close approximation to free cash flow?)
Once you calculate a free cash flow that you believe to be true, and you are able to buy it at a reasonable multiple, why should it matter to you whether or not the company that produces these cash flows is involved in a capital-intensive industry?
The only thing I can think of is that being a capital-intensive industry seems to be closely associated with generating relatively low ROA, which will limit a company's ability to finance expansion with internally generated cash. But if the industry is relatively mature, with little prospects for expansion (i.e., the inability to generate rapid internal growth doesn't matter, since such opportunities are unlikely to arise), should this deter your investment?
- Daniel |
