Manufacturing: Investing Essentials

Finding manufacturers at the cutting edge could reveal promising investment opportunities. But before scouring the markets for promising manufacturers, it's important to understand the basics of the sector.

Aug 11, 2014 at 10:05AM

Manufacturing is at the heart of innovation. As companies continue to look for ways to become more frugal, improve quality, and optimize operational efficiency, material-reliant businesses will look to manufacturing to carve out key competitive advantages. Finding manufacturers on the cutting edge, therefore, could reveal some promising investment opportunities. But before scouring the markets for promising manufacturers, it's important to understand the basics of the sector.

What is manufacturing?

"The Manufacturing sector comprises establishments engaged in the mechanical, physical, or chemical transformation of materials, substances, or components into new products," according to the Bureau of Labor Statistics.

More specifically, in the manufacturing sector, you'll find plants, factories, and mills that typically operate automated machines and equipment alongside factory workers. Manufacturing may be 100% vertically integrated, or a manufacturer may outsource the processing of some of its components with other businesses.

Examples of manufacturing businesses include solar panel manufacturers, chemical manufacturers, textile product mills, metal manufacturing, and petroleum and coal products manufacturing.

How big is the manufacturing industry?

There's no way to really overstate the importance of manufacturing in the economy. Today, manufacturing represents about 16% of the global GDP, according to a 2012 McKinsey Global Institute study on the manufacturing sector. Or, here's another way to put it: After lumping together the top 500 U.S.-based manufacturers in 2012, total annual revenue exceeds $6 trillion. An article on Free Enterprise, the U.S. Chamber of Commerce's online magazine, has noted that this batch of manufacturing companies alone would rank as the world's third-largest economy, behind the U.S. and China, but ahead of Japan with its 2012 GDP of $5.98 trillion.

How does the manufacturing industry work

The operational aspects of manufacturing businesses vary widely from one kind of manufacturing to another. But here are some general rules of thumb about manufacturing companies.

Most forms of manufacturing, due to a heavy reliance on machinery, plants, and resources, are highly capital intensive. This also has an effect on barriers to entry, often making them high.

R&D intensity is high for manufacturers competing globally and medium for those competing regionally. This likely has much to do with the global companies lacking the same powerful market monopolies that some regional players may have.

The newest and most rapidly evolving operation aspect of manufacturing is the importance of information technology to the sector, often referred to as "big data" in the manufacturing environment.

"Major information technology trends such as big data, advanced analytics, social technologies, and the Internet of Things all can be harnessed in supply chain management and other aspects of manufacturing," reads the 2012 McKinsey report.

What are the drivers of the manufacturing industry?

Economic conditions are a major driver for the manufacturing industry. Consider the volatility of the purchasing managers index during the 2008 and 2009 recession compared to the volatility of the S&P 500. The index is an indicator of the economic health of the manufacturing sector and is based on five key indicators: new orders, inventory levels, production, supplier deliveries, and employment environment.

ISM Purchasing Managers Index Chart

ISM Purchasing Managers Index data by YCharts.

During bad times, the index plummets. During good times, the index soars.

Why is the economy such a major driver for manufacturing? It can be traced back to two key reasons.

First, access to capital -- both equity and financing -- is more costly during tough times as banks and investors become more conservative. And given the high capital intensiveness of manufacturing businesses, large sums are often required to take on new projects, expand capacity, increase production, or retool and revamp a current factory.

Second, global consumption may slow, or even decline, when the economy suffers. Consumption is a closely followed metric in the manufacturing industry because consumption directly (through direct consumption of manufactured goods) and indirectly (through creating demand for capital investments that, in turn, boosts demand for manufacturing) impacts the health of the manufacturing sector. Different manufacturing sectors are tied to different consumption metrics. U.S. defense manufacturing companies are driven by U.S. defense consumption of manufacturing goods, steel manufacturers are tied to steel consumption, etc.

Looking at the global manufacturing market, meaningful growth in global GDP indicates that the global manufacturing sector will likely be healthy.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information