Value Creating Sectors

Over the long term, a company’s stock price is a function of it’s ability to create value for others. In the short term, investors might over or underestimate that potential, so this isn’t a perfectly accurate model. That said, I think it offers an interesting way to look at companies and their ability to create value for others.

I went through the major sectors of the US stock market and divided their current ETF price by their price at the beginning of 2007, roughly 11 years ago. The result gives you an answer for how the biggest companies in these sectors have multiplied their wealth-creating potential. It doesn’t account for dividends, which are admittedly an important source of return for shareholders. Nor does it account for changes in valuation (financials in 2007 were priced aggressively high relative to where they now sit). My counter-arguments to these two points are that wealth-creation is much easier with a high share price than with a low share price. The cards dealt to you are different, but the game remains the same. Secondly, I’m looking at the capacity of a company to produce new wealth. A company that consistently pays out 90%+ of its earnings as dividends may generate a good return for investors, and seemingly it has produced a good amount of wealth in the form of profits. But its share price will be flat if it has not expanded it’s ability to produce wealth. The point of owning equities, rather than bonds after all, is the potential for your investment to expand its earnings (ie its capacity for value-creation).

Consumer Discretionary (XLY) 2.82

Consumer Staples (XLP) 2.53

Energy (XLE) 1.44

Financials (XLF) 1.17

Healthcare (XLV) 2.93

Industrials (XLI) 2.64

Technology (XLK) 3.24

Basic Materials (XLB) 2.28

Telecommunications (IXP) 1.04 (used global rather than US, because US had not data available for 2007)

Utilities (XLU) 2.07

The top-ranked sectors for value creation, then, over the past 11 years are:

  1. Technology (XLK) 3.24
  2. Healthcare (XLV) 2.93
  3. Consumer Discretionary (XLY) 2.82

And the bottom sectors are:

  1. Telecommunications (IXP) 1.04
  2. Financials (XLF) 1.17
  3. Energy (XLE) 1.44

This all ties in with my entrepreneurial thesis that the point of business is to create value for others. A great company creates a lot of value, and a mediocre one does not. In fact, many mediocre companies actually destroy value. In the short term, they survive by over-charging for their services and creating obstacles for new entrants. But in the long term they are found out and supplanted by newer, better companies that are more dedicated to increasing the overall wealth of the world than in extracting profits in the present.

The big takeaway is not to invest in this or that sector over the others, but to change your thinking from “will this go up? Can I buy low and sell high?” to “what are the companies that are most committed to and capable of expanding the wealth of the world?” And eventually, to embracing this idea in your own life by asking, “how can I offer more value to others?” whether in your business or in your personal life.