Selecting the right companies and stocks is critical for a successful investment strategy. This can be a time consuming process which is why many analysts prefer to conduct a “Top Down” analysis that focuses on identifying growing sectors before exploring individual companies.
By analyzing past trends, current supply and demand, and future outlook, it’s much easier to identify which sectors are expected to grow more than the average market. This also allows investors to spread their investment across similar firms in the same sector to diversify their portfolio and minimize risk. Here are 6 approaches every investor can leverage to identify growing sectors.
1. Review Existing Industry Analyses
Most sectors already have teams of analysts that provide comprehensive analyses and reports related to specific industries. These publications can come from sources such as industry trade groups or consulting firms (such as IBISWorld or Deloitte) and contain well-researched and reputable data and information. Instead of starting your analysis from scratch, you might see what other experts are saying before you “recreate the wheel”.
If you find that two or three reports with positive sentiments, it could be an indication that you are on the right track to identifying a growing sector. Of course, it’s important to always validate the findings with your own research prior to making any financial decisions.
2. Compare Individual Sectors to the Overall Market
A strong indication of a growing sector is one that shows growth that exceeds the overall market average. There are a few metrics that you can use to compare the two including earnings growth, price-to-earnings (P/E ratio), share price performance, and return on equity (ROE).
First, start by looking at the average growth of the overall market over a period of time (for example, the last three years). Once you’ve established the market average, compare this to the same metrics for the sector.
If the sector shows a consistent record of beating the market average, it could indicate the sector is growing. When conducting this equity analysis, be mindful of factors that could cause the sector to show temporary growth that is out of the normal range (for example, the tech industry bubble of the early 2000s).
3. Analyze Trends Based on Multiple Timeframes
Too many investors make the mistake of investing in stocks or sectors that appear to be headed in a certain direction only to find out this was a microtrend within the big picture. For example, a sector may have really strong performance over the last year but has consistently lost value over the last decade on average.
To avoid this challenge, it’s best to look at multiple timeframes to ensure that the upward trajectory isn’t an isolated event. These timeframes may vary by sector depending on how quickly the sector innovates and changes over time.
4. Deep Dive into Sub-Industries
Many sectors are large and complex. The real estate sector for example consists of various sub-industries such as property development, residential rentals, commercial and industrial properties, facilities management services, and property management.
Analyzing a sector at the highest level may not provide a full picture of how the sector is actually performing. For example, the technology sector is expected to see large growth in artificial intelligence in the near future. However, this sub-industry only makes up about 1.5% of the total global technology market today and has less influence on the sector’s current performance.
5. Examine Future Demand
Historical data is a great starting point when looking for growing sectors. However, there is no guarantee that past performance will produce future results. The change in growth year over year can help you better understand if demand is increasing or decreasing.
For example, if one sector grew 7% last year and is expected to grow 10% this year, demand appears to be accelerating. If the opposite is true (10% last year and 7% growth this year), this could be an indication that demand is slowing. If this trend continues for multiple years, the sector likely is stalling or may flatline in the future.
6. Consider Non-Analytic Indicators
Not all indicators of a growing sector can be tied to actual data points. Global markets are often moved up or down by consumer sentiment or human emotion. Non-analytic indicators should be considered a part of your overall analysis.
The tone in press releases, new product innovations, changes in government regulations and restrictions, consumer buzz on social media, and market rumors can all provide indications of a sector that is anticipating future growth. While these are all subjective indicators, they shouldn’t be ignored entirely.
The great news is that there are numerous options when it comes to gathering and analyzing data needed to identify growing sectors. Technology is making this more accessible and faster. Many analysts are starting to turn to cutting-edge tools such as AI analysis to improve their ability to spot investment opportunities. No matter what tool or process you use, your success will depend on your ability to spot these growth opportunities quickly and early.