Investing in Basic Materials Stocks

The basic materials sector produces many of the building blocks needed to make the things we use every day. That makes it an important industry for investors to know about.

What is the basic materials sector?

Demand for basic materials is cyclical, making the sector's participants highly susceptible to changes in the health of the economy. If economic conditions weaken, demand for basic materials tends to decline, which lowers their prices. That affects the profitability of basic materials producers.

The economic cycle is only one of many factors that can affect the materials sector. Supply chain issues, new legislation, and inflation are just some of the other factors that can affect basic materials demand, prices, and industry profitability.

For example, in 2022 a new headwind emerged in the sector in the wake of Russia’s invasion of Ukraine. The war disrupted the global supply chain for basic materials because the region produces vital metals for making steel and minerals for fertilizer, such as potash. The supply issues drove up the prices of most basic materials, greatly affecting the sector and the broader economy.

Keep reading to learn more about the best materials stocks and whether investing in them is right for you.

Top basic materials stocks

Although many companies operate in the basic materials industry, the following three stand out as some of the top basic materials stocks for investors to consider:

1. Rio Tinto

Rio Tinto is one of the world's leading mining companies. The London-based company produces the three top industrial metals -- iron ore, aluminum, and copper -- and several other important metals and minerals.

Rio Tinto focuses on these industrial metals because they are the ones the global economy most commonly consumes. The uses for iron ore, aluminum, and copper are numerous and growing:

• Iron ore: The primary material for making the steel used for cars, appliances, buildings, wind turbines, and other infrastructure.
• Aluminum: A lightweight metal and a vital component for many technology applications. Aluminum is used to make jet engines, electric vehicles, and mobile phones.
• Copper: Copper is an excellent conductor of electricity, making it essential for electronics, electric vehicles (EVs), and for producing solar energy. It is also a vital component of many technology applications.

Although these metals are highly sensitive to cyclical changes in the global economy, demand for the metals Rio Tinto produces should continue to grow.

The company also boasts a strong balance sheet and some of the lowest-cost operations in the world. It has the financial flexibility to expand its operations while returning cash to investors via share repurchases and dividend payments. As a result, Rio Tinto is well-positioned to cope with changes in demand for these commodities and create value for its shareholders.

2. Nucor

Nucor is the largest and most diversified steel and steel products company in North America. It’s also the continent’s largest steel recycler.

The company’s focus on steel positions it for two megatrends. First, steel is essential for making wind turbines, so it’s vital to the renewable energy industry. Steel is also crucial for infrastructure, such as bridges and railways, making it a beneficiary of increased infrastructure spending.

Nucor has a low and highly variable cost structure. Because of that, it has a long history of generating free cash flow throughout the cycle. The steelmaker has maintained a strong balance sheet and delivered its 49th straight annual dividend increase in late 2021. The increase put Nucor in the elite class of Dividend Aristocrats and on track to become a Dividend King.

3. Air Products & Chemicals

Air Products & Chemicals is one of the world’s leading industrial gas companies. It supplies essential industrial gases to the refining, chemical, metals, electronics, manufacturing, and food and beverage industries. It’s also a leading global supplier of liquefied natural gas (LNG) process technology and equipment.

The company is a major supplier of hydrogen, which could play an important role in fueling the economy in the future. In addition, its expertise in carbon capture and storage could help reduce greenhouse gas emissions. Add that to its importance to the growth of LNG, a widely used fuel, and Air Products is playing a vital role in helping the global economy transition to cleaner energy sources.

Air Products also boasts a strong financial profile, including an excellent balance sheet and healthy cash flow. That gives it the financial flexibility to expand its operations and pay a growing dividend. The company is a Dividend Aristocrat and delivered its 40th consecutive annual dividend increase in early 2022.

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Should you invest in materials stocks?

While all companies in the basic materials sector face risks related to the health of the economy, the best materials companies are well-positioned financially and benefit from a diversified portfolio of operations. The top materials companies have multiple businesses, investment-grade bond ratings, manageable debt, and low production costs. These factors enable them to still make money even when materials prices decline.

Materials companies are more likely to perform well when the economy is booming, making these companies a better buy in bull markets. But, even when the economy is growing, fierce competition in the materials sector tends to restrict companies' abilities to generate substantial profit, which affects share prices.

Inventors need to be very picky when choosing basic materials stocks to buy. They need to focus their attention on well-run, financially strong companies with visible growth prospects. A sharp focus increases the probability that materials stocks can deliver attractive returns for investors.