Investors may be risk averse or may want to seek riskier investments with the potential for a better return. Well-diversified investors hold both types of investments in their portfolios - some fraction of their equity holdings are high risk along with equities considered less risky. One simple way to define risk is that the equity considered for investment may not return what you expect, and or you may lose some - or in rare cases, all - of the money you invested.
Calculating equity investment risk is a complex process and requires the evaluation of several factors. First, what is the state of the overall economy? A vigorous economy suggests that stock prices will generally rise. However, this is not true of all industries. Companies currently in a growth phase - such as the telecommunications industry - seem to have good prospects for an increase in share price.
Industries in the mature phase of their businesses - that is, have been around for several years and established large market caps - may not have much potential for exponential growth and their share price may often remain flat, or trade within a narrow range. Companies that have been around for a long time and that have been hurt by the real estate bubble, such as home building, may fall into this category. New home starts, for example, are currently at low levels and do not augur well for a short-term increase in the share prices of industries connected to home building, such as construction, wood products and cement. Also affected are appliance makers, home furnishings and other related industries.
There are other factors as well in the risk-reward equation, including interest rate risk, new taxes levied against certain industries, which would influence specific equities, the risk of inflation and the general health of the national and world economies.
Changes in senior management, unsuccessful marketing and advertising strategies, mergers and acquisitions that don't produced the desired results, too much debt, loss of revenues due to changes in customer preference and other factors, are all potential risks for a company. A specific company may flourish with a corresponding increase in share price and return, while other firms offering the same goods or services may flounder.
With these factors in mind, let's look at what industries have generally done well - meaning total return over the past five years during which the Dow Jones Industrial Average and the S&P 500 have been down and up, and back again.
Utility Stocks have survived market volatility with prices not varying much and have paid dividends of as high as 3% more than Treasury securities. Among other sectors showing positive and significant percentage returns over the past five years are the following (not every company in each of these sectors, however, posted positive returns.) The data listed below runs through to June 27, 2012:
- Apparel Stores
Total Five-Year Percentage Returns:10.01. This category includes such retail giants as TJX Companies, Jos. A. Banks Clothiers, and Gap, Inc. (NYSE:GPS)
- Beverages Brewers.
Total Five-Year Percentage Returns: 16.56. High-profile names in this category includes Anheuser-Busch (NYSE:BUD), Molson Coors Brewing Co., and United Brewers Company, Inc.
- Beverages Soft Drinks
Total Five-Year Percentage Returns: 9.18. Familiar brands in this group include Coca Cola Co. (Nasdaq:KO), PepsiCo, Inc. (NYSE:PEP), and Dr. Pepper Snapple Group. (NYSE:DPS)
- Computer Systems
Total Five-Year Percentage Returns: 16.03. Among the leading firms in this area were Apple, Inc. (Nasdaq:AAPL), International Business Machines, and Acorn Energy, Inc.
- Discount Stores
Total Five-Year Percentage Returns: 9.55. Big players in this sector include Wal-Mart Stores, Inc., Target Corp., and Family Dollar Stores.
- Health Information Systems
Total Five-Year Percentage Returns: 14.04. Included in this sector are SXC Health Solutions Corp., Catalyst Health Solutions, and Mediware Information Systems, Inc.
- Industrial Distribution
Total Five-Year Percentage Returns: 10.06. Major firms in this group include W.W. Grainger, Inc., Transportation Components, Inc., and Hudson Technology, Inc.
Total Five-Year Percentage Returns: 13.73. Among the firms serving hungry consumers in this sector are Chipotle Mexican Grill, Inc., Papa John's International, Inc. and Panera Bread Company, Inc.
- Specialty Chemicals
Total Five-Year Percentage Returns: 8.39. Leading companies in this group include W.R. Grace & Company, Poly One Corporation, and NewMarket Corporation.
Total Five-Year Percentage Returns: 15.53. Despite multitudes of research-backed campaigns advocated the health risks of consumption, some tobacco firms continue to flourish. Among them are Lorillard, Inc., Reynolds American, Inc., and Caribbean Cigar Company.
The Bottom Line
Every sector and every individual business within a sector, faces risks, some predictable, others not predictable. Calculating risk is not an exact science because so much depends on ever-changing market conditions, investor confidence, varying interest rates and changing consumer preferences, to name just a few of the many variables.
The sectors and individual companies cited above have done reasonably well over the past half-decade. That's no guarantee that they'll perform equally as well in the future. One investment axiom, however, holds true no matter what: the higher the risk, the higher the potential return on investment - if things turn out as hoped.
Marc Davis does not hold stock in any companies mentioned in this article.