Investing in the Basic Materials Sector
Overview of the Sector
The basic materials sector is made up of businesses involved in the development, discovery, and processing of raw materials. This sector consists of companies engaged in metal refining and mining, oil, forestry products, and chemical products. The raw materials they develop are purchased by nearly all other industry sectors. This sector is especially sensitive to the booms and turmoils of the economy.
Companies within this sector supply most of the materials used in construction. This makes the companies and their stocks vulnerable to changes in the economic cycle. They tend to flourish when the economy prospers.
If the economy weakens, demand for these products, as well as pricing, tends to drop, which reduces the stock prices and profitability of basic materials companies. That was the case in early 2020. As the pandemic outbreak weighed on economic growth, it knocked the basic materials sector hard. The returns of the basic materials sector indexes went down by an average of 25% during the same period. Because of these factors, investors need to be cautious when looking for basic materials stocks.
Stocks and ETFs That May Be Considered For Investing
The materials sector is made up of companies that make basic materials we use in everyday items. The major businesses include:
- Construction- This industry comprises companies that deal primarily with the construction of roads, bridges and buildings. They also produce steel-related products and lumber.
- Chemicals- Companies that convert raw materials to industrial synthetics and chemicals, such as plastic.
- Containers and packaging- They create the design and manufacture various types of packaging, like paint cans, aluminium food containers and cardboard boxes.
- Metals and mining- These companies locate and extract metals and minerals like bauxite, silver and gold.
- Forest and Paper products- This industry is focused on growing and harvesting timber, lumber and paper.
- Agricultural Inputs– Companies that make fertilizers and other soil and crop additives.
Popular Basic Materials Stocks that may be Considered:
DuPont de Nemours, Inc. (DD)
The company provides electronics, construction materials, fabrics, resins, adhesives, materials for solar cells, and other products. The company serves customers in the automotive, energy, government, packaging, military and construction industries. The company has a market capitalization of $45B & the stock is trading at levels of $76.
Rio Tinto Group (RIO)
This group engages in mining, exploring, and processing mineral resources globally. It produces all three key industrial metals- aluminium, iron ore, and copper and some other important minerals and metals. Rio Tinto has one of the lowest-cost operations in the world in its sector. Some factors driving down costs are its leadership in innovation, use of autonomous drills and trucks as well as data science and analytics. These things reduce expenses and improve productivity. The corporation also has a strong balance sheet.
The company has a market capitalization of $141B and stock is presently trading at levels of $88.
The Mosaic Company (MOS)
The Mosaic Company, along with its subsidiaries, manufactures and markets potash crop nutrients and concentrated phosphate in North America and globally. The company runs three segments: Potash, Phosphates and Mosaic Fertilizantes. The company provides industrial products, feed ingredients, potash ,concentrated phosphates, and related products to agricultural customers. The company has a market capitalization of $14B and stock is presently trading at levels of $37.
It is one of the largest chemicals, plastics, and refining companies across the globe. It produces products that are important for protecting the purity of water supplies, food safety and improving the comfort, safety, and fuel efficiency of vehicles. The company manages quite low cost of operations along with a diversified portfolio of products. These factors enable it to generate lots of cash flow and gives it the funds to expand its operations through strategic joint ventures, organic growth projects and acquisitions while returning money to stakeholders via share repurchases and dividends. The company has a market capitalization of $39B and stock is presently trading at levels of $117.
Celanese Corporation (CE)
Celanese is a global producer of advanced materials and chemicals. It produces acetate, acetyl, engineered polymers and vinyl emulsion. For Q1 2021, it reported a 47% year-over-year (YOY) increment in earnings and strong growth in net sales. The company attributed the growth to improving demand price increases. The company has a market capitalization of $19B and stock is presently trading at levels of $167.
International Paper Company (IP)
International Paper is one of the world’s largest producers of pulp, paper, and packaging. The company makes most of its cash from industrial packaging, such as cardboard boxes used to ship food. It also makes cellulose fibres (absorbent materials) and printable paper products. It focuses on being one of the lowest-cost producers of the products it produces. It keeps costs down by operating manufacturing units near timber forests, thus giving the company low-cost materials of sustainable wood fibre. It also controls costs through operational innovation and excellence. The company has a market capitalization of $25B and stock is presently trading at levels of $64.
Some ETFs that follow the sector:
- First Trust Materials AlphaDEX Fund (FXZ)
- Materials Select Sector SPDR ETF (XLB)
- Invesco S&P 500 Equal Weight Materials ETF (RTM)
- Vanguard Materials Index Fund (VAW)
- SPDR Metals and Mining ETF (XME)
However, before making any investment in the stocks, one should analyse the fundamentals of a company such as market capitalization, dividend yield, PEG ratio, PE ratio, dividend payout ratio, stocks’ return and other important ratios. Of course, no investment is without risk, and ETFs are no exception.
One’s goals as an investor should always play a role in allocation decisions. For example, if you want high dividends and moderate growth, basic-materials stocks aren’t the most appropriate choice. Instead, you should search for utilities stocks.
Pros of Investing in the Basic Materials Sector
▪ There will always be demand for Basic Materials
The materials sector is essential for a lot of industries. It affects manufacturers, construction, metals mining companies, and basically any entity that manufactures a product. Raw materials are important to the economy.
▪ Act as Safe Havens
For investors, the materials sector is also beneficial to a portfolio. Investments in this sector can be used to diversify a portfolio, increase exposure, take advantage of an opportunity or hedge risk. The best example of a safe-haven basic-materials company is a gold miner. In times of economic hardship, investors tend to sell-off stocks in general and use those funds to buy gold and silver commodities. As a result, the economy declines and results in gains in the values of precious metals.
This is great for the companies that mine these metals as the cost of mining reduces due to reduced cost of fuel. At the same time, the money these companies charge for their end products increases in response to the demand from safe-haven investors. This means reduced expenses, increased income, and, ultimately better profitability, sending the stock prices upward. Many materials stocks also generate regular cash flow and return cash to shareholders through consistent dividends.
▪ Cyclical in Nature
Some of these stocks are cyclical in nature that makes them relatively simple to time. By paying attention to the daily news, one can get an idea of economic conditions. When conditions are positive (bullish), it is time to buy; when conditions are negative (bearish), it’s time to sell. Having the ability to use economic conditions to time your investment decisions adds another tool to your investing toolbox, thus expanding your opportunity to make profits and potentially beat the market.
Cons of Investing in the Basic Materials Sector
▪ Sensitive to Global Economy
The materials sector is especially sensitive to international politics, global economy and fluctuating demand. For example, materials stocks can suffer during geopolitical tensions and trade wars. Taxes and tariffs can lead to higher prices, which can negatively impact sales.
▪ Cyclical Isn’t Always Good
Materials stocks can also plunge when there is low demand, especially during economic downturns. Also, while cyclical stocks make timing a bit simpler for the investors, the entrance and exit timing should always be considered. With slow-growth dividend plays, timing isn’t as important because these stocks will generally trade flat. Conversely, because cyclical stocks can plunge during tough economic times, making an ill-timed investment will prove to be tremendously costly.
▪ Big Companies May Not Generate Profits
Mining and other activities involved in the processing of basic materials is extremely expensive. The only way to make any profits is to have a massive operation. This causes profitability issues, even to some of the big players. It is common to find materials companies with ballooning market capitalizations that don’t make any profits at all.
Intra Sector Comparison using MarketXLS Template:
MarketXLS provides a ready-to-use template for facilitating intra sector comparison on the basis of Market Cap. for various sectors. Using the Intra Sector View template, the Investor can select the ETF and compare the companies that are part of that index. The investor can also modify the stocks/components of the ETF based on his requirement. The comparison is based on CMP, Market Capitalisation, P/E, Revenue, and Profit Growth, ROE, and ROC indicators.
You can click here to go to the template. The template will also present detailed analysis and fundamentals comparison graphically for a better understanding.
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There are a number of advantages to adding basic materials stocks to your portfolio. Basic materials stocks mainly track economic trends and considering their dependence on the performance of the economy, they can be attractive investments in a flourishing economy. The trading of these stocks is considered relatively safe because of the relative stability in their demand experiences when the economy is expanding and strives for growth.
However, there are also some demerits to the same. Basic materials stocks can increase the volatility of one’s portfolio because of their dependence on economic cycles. During a rise in international tensions, for example, these stocks can follow significant nosedives as companies are exposed to more sanctions on the trading of various commodities that come under the basic material sector.
The pandemic has affected the basic materials sector severely, because of the contraction in demand and consumption in sectors that are commodity heavy. This downturn served as an important indicator that companies operating in the sector must have low costs and strong balance sheets to get through these tough economic times.
It is advisable to have a genuine interest in anything you want to invest in. So, if you are looking to invest in basic materials stocks, you should have a general interest in learning about these materials and the industry that surrounds them. A readiness to keep up with the news of the economic conditions may serve your purpose.
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