Best Industries to Specialize In
Am interested in learning the community's thoughts on what are some of the best industries to start off in for equity investing at a hedge fund?
Is it advantageous to start in cyclicals (e.g. chemicals) vs growth (e.g. tech)? What about highly specialized industries (e.g. O&G or insurance)?
Would note that this discussion has been discussed in the link below but wanted some fresher perspectives: https://www.wallstreetoasis.com/forums/equity-research-if-you-had-the-c…
I would say you want to find industries where there is a lot of alpha available. Energy, insurance (financials in general), REITs are all very macro oriented. They depend on commodity prices and the yield curve.
I think that tech is a phenomenal choice right now. There is so much happening as we embrace the digital world. If you take a couple of months to dig deeply into AMZN, GOOGL, FB, AAPL and MSFT, you will have an overview of where society is going. Some will say that it is difficult to have a differentiated view on such well-covered companies. That may have some truth to it (although I find that there is still a decent amount of skepticism out there), but these companies spend a combined $50B+ on capex and a similar amount on COS.
Find the datacenter beneficiaries, the component suppliers, the content purveyors, whatever. There is so much emanating from the wakes of these five companies.
I'd echo the earlier commenter, choose sector with most idiosyncratic outcomes, volatility and dispersion. Should also be something that you can see yourself developing expertise in, find interesting or are passionate about.
I'd rank them broadly:
Technology Healthcare Consumer Industrials Financials/Real Estate Utilities
I like to think big picture and boil it down to its most basic roots:
1.) Technology - This shit revolves around everything you do on a day to day basis. 2.) Healthcare - Everyone needs this shit to survive. 3.) Consumer Goods - People will never stop buying and trading shit.
There are three constants in human societies: Advancement of technology, advancement of medicine, and necessity for exchange of goods & commerce (it makes the economy tick).
You're the shit.
"If it doesn't make dollars it doesn't make cents (sense)." - Curtis Jackson
RE is probably the most basic good/asset class.
Would agree w/ these as top three but would put consumers above healthcare, for the reason that it is just much harder to build conviction in healthcare stocks on avg. vs. consumer stocks. Too many uncertainties (outside of med tech)
Cyclicals
While it may not always be possible, I'd stay generalist as long as you possibly can. Unless you have a true passion for a particular industry, you may end up shoehorning yourself into something you are really not that interested in.
Something you will enjoy learning about and find intellectually stimulating so you can then master your understanding of the space and thus have an advantage in delivering alpha/good investment ideas.
If you are going to do this for the rest of your life as a career, then I would pick an industry that you are actually interested in. I could specialize in insurance, for example, but I would literally kill myself after awhile.
I will add a slightly contrarian perspective/ insight: you also want to choose a sector where you will be differentiated and competition will be relatively limited.
Tech is incredibly crowded because it is the 'obvious' choice. The products are highly visible in popular culture and the space is constantly evolving. The downside is that every schmuck thinks they can have a differentiated understanding of FANG (or is willing to try).
Add to that the fact that much of internet/ growth tech requires limited 'deep' analysis and is 'finger in the air' 'secular growth vs. secular decliner' stuff. While a lot of industrials are 'gdp +/- growth' and you focus on the rest of the model, a lot of growth tech is largely about getting the revenue growth rate correct. This kind of directional guesswork is relatively easy to do (though almost impossible to be particularly accurate at), attracting a lot of people that aren't really about that modelling stuff.
What sectors aren't easily crowded by lazy 'generalist' schmucks? Financials, healthcare, and energy - all require some significant domain expertise.
Overall though, I think I would put my vote on industrial. It's the best of both worlds - a big space that has a lot of things you interact with / understand intuitively (cars, trains, planes, houses, furniture). However, it also involves some domain knowledge asnd some serious analysis below the top line (i.e. cost structures, incremental margins and returns, etc).
Someone above also said 'try to be a generalist as long as possible.' This sounds like a good idea, but often just results in you being not quite as smart as the reserve investor across a number of fields. Its harder to pull off, but I might recommend trying to spend time specializing across multiple sectors (i.e. make at least 1 or 2 sector moves in your career)
Just my two c as someone who's worked across several sectors.
My votes are industrials and healthcare. You'll learn to do actual primary research, and learn how to model fixed/variable costs properly. As implausible as it sounds, those are two skills that genuinely differentiate you as an analyst. Healthcare also teaches you how to trade/invest around news flow.
Generalist analysts frequently get burned in these sectors ('industrials look cheap' - end up buying at the peak of the cycle / 'healthcare is simple' - end up buying Valeant). This increases the value of specialists.
Tech is fun, but most tech, esp. the consumer-facing stuff is just guessing TAM , penetration rates, ARPU, etc. Very difficult to build repeatable edge. Let's say you 'estimated' FB's growth correctly in the past - how does that make you a better investor in TWTR or SNAP in the future?
Would that be applicable to banking as well? Or being in a slightly better group would be better?
I agree w/ the first two paragraphs, but could not disagree more with the last one. You can absolutely build conviction in tech / consumer stocks.
The commentary from below on tech vs. industrials isn't as simple/complicated as people believe. Tech is incredibly varied - semiconductors for example are very similar to industrials in they are cyclical businesses with GDP+- end demand markets and very detailed focus on incremental margins, fixed/variable costs and inventory accounting. Outside of NVDA and AMD most semis are not pie in the sky revenue growth models that are based on some intangible addressable market in the future. Then you have software. Do you know why half of software trades at infinite earnings multiples? It's because they basically represent NPVs of recurring revenue streams and the best companies can reinvest 100% of their proceeds to get additional revenue. Software is basically a series of present value equations based on growth, churn, pricing and incremental/decremental margins from that pricing. Generalists investors thus get destroyed in software if they are buying/shorting based on multiples on their models.
Then look at internet. Amazon is a capex intensive businesses where there is a ton of modeling you can do on the incremental margins and capacity utilization on new fulfillment centers (on the retail side) and data centers (on the AWS side). The best analysts on AMZN were the ones who can understand the unit economics of new data centers and how to think about the flow through of the various business lines to both gross margins and operating income. GOOG has the same dynamic as AMZN. FB and NFLX are a little bit softer but you can definitely do in-depth work on the margin side by looking at the new engineers, cost per new engineer, and think about how the costs can truly grow with revenue based on the limited pool of demand in the valley.
Then on primary research, tech has ton of opportunities. Talk to the software resellers and partners and see how they are doing and what trends they are seeing. Talk to the fabs in Taiwan to gauge end market supply/demand. Talk to the people at AWS reinvent and Strata to figure out what is happening in the database environment.
Tech is a great space and definitely not just about clicks, eyeballs, and buzzwords like AI. Ultimately, the best part about tech is that outside of certain segments like semis, they are predominantly high quality businesses ("compounders" though I hate that phrase as it has become a catch all for everything that is 15x ebitda these days) with long-term growth opportunities. Unlike industrials, you do not need to time a cycle right to do well because over a long enough period of time your stocks typically go up because the intrinsic value of the businesses are growing and the multiples are not high enough where the multiple compression will mask the underlying growth of the businesses over a multi year holding period - as a result you see a ton of the top LT investors have big weightings in tech
This is spot on. Tech outside of large cap internet provides lots of opportunity for alpha gen
Great comment +SB. You are spot on that tech is incredibly varied, with a variety of business models and opportunities for alpha generation.
My prior criticisms were meant to be somewhat contrarian and focused on a particular set of investors that has really grown in the last ~10 years. These are the 'tech' investors that only do internet/ software (dead giveaway when someone says I do 'tech', but not 'hard tech') and are not particularly thoughtful ('finger in the air' ). Even some of the sharper ones have a hard time avoiding 'VC-ization (where they start thinking of themselves as visionaries instead of analysts). Don't be one of these.
It might be cyclical (pun intended), but I've also realized as I move more into mid-career/ trying to get sector head/ PM jobs that there are a ton of TMT people out there (especially media/telecom/ internet, much less so hardware) and very few industrial. I would honestly expect that to remain the case going forward, with more analysts/ investable name (though not necessarily per unit of market cap) focused on internet and software in particular. From a headcount perspective U.S. public equities is not a growth industry, so this is important to take into account
Any examples of good analysts in the mold that you are talking about? Would that guy from Elliott be an example, I think his name is Jesse Cohn.
You pose a very interesting point, about the differentiation between types/styles of tech investors.
Agree- spot on- SB'd. Tech's a lot more than just FANG. The above is a great way to dissect the sector.
Industry Specialisation (Originally Posted: 01/16/2014)
Hey all.
Imminently starting a job as a strategy analyst. I'm interested in hearing about what industry specialisations you're all keen to pursue and why. There are just so many, and being from a humanities background, I'm a little overwhelmed! I imagine I'll be exposed to at least a few different industries once I've begun anyway, but I get the impression it still pays to have strong ideas about where you want to be.
I think public health and government seems like an interesting option, and it ties quite nicely into my interests in public service and the public sector. But I also feel as thought it would be fantastic to cultivate a skillset in energy, given how dynamic the industry is in terms of new technology. Pharmaceuticals for the same reason, and also the potential to understand the healthcare industry better. I'm also attracted yo natural resources or utilities, since they present interesting challenges in terms of sustainability.
I guess financial services will be really popular, but that sort of leaves me cold by comparison to the ones I've listed. Same goes for retail/products.
What about all of you?
I believe the best advice you can get is to use your first 2 years to build a solid and diverse skillset base by trying out several different industries.
That being said, I agree with you that once you find something you would like to pursue you should aim in getting staffed on those kind of projects.
I don't think, however, that you can get a very good insight of what industries are good fit for you before actually trying them out. The fact that you like, or have interests in one or another specific subject does not mean you will like working with it. I mean, I sure like the impact of the work in government, but would I like putting up with all the politics behind a project?
So, keep your mind open to the possibilities, and thrive to do your best in all projects. Once you find something you like, you will surely benefit from your vast exposure to other subjects, because it brings you perspective.
Best advice I've gotten regarding this. First year or two, doesn't matter what industry you work in. Every firm and every office is different, w/ different strength in different industries, or excels at a specific type of work in an industry. More likely than not, your initial "interest" areas will not match the firm/office/state of business combination when you join.
You are better off find a group of people you enjoy working with, and that enjoy working with you. IMO, enjoying the people you work with and having great working relationships w/ a few partners in an industry will beat out anything else you will get in your first year or two. It will help you get more responsibility early, get on cooler projects, faster promotion, and develop a better reputation. That is pretty much the key to success here.
Agree with earlier posters.
You should (and probably will be anyway) try to be exposed to as many different industries as possible during your first two, three years. Almost everyone start out as a generalist in the management consulting industry. During this time you'll gain experience in lots of industries and hopefully you'll find one that you find particularly interesting. After two, three years you should aim to specialize and gain expertise in the industry you chose.
This is what's called the "T-profile" in consulting. You start out broad as a generalist (The hat in the T) and then you specialize and get deep knowledge in a industry or area (the I in the T).
Even though it may seem most interesting to stay generalist throughout your whole career (Hey! Different projects in different industries all the time! Always something new!) you'll be a hard sell to clients as a senior with no specific expertise. Though this changes when you get very senior and can get back to being a generalist, as your many years of experience is enough to sell you the client no matter area or industry (most times).
I did this transition myself recently. After being a generalist for three years, I've now specialized in telecom and my aim is to be considered an expert and go to-guy in this area.
Contrarian viewpoint, since sell-side specialists have almost zero proven ability to pick winners within sectors what makes you think being a "pharma specialist" e.g. is such a valuable asset to a fund?
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