Ask The Rational Investor: What is the best way to invest in the automotive sector?
Let’s imagine for a minute that all global stock markets close tomorrow, without notice, for five years. How comfortable would you feel with your current investments? Would it be easy to sleep?
One reason we have long preferred to purchase individual stocks and bonds is that controlling the quality of companies that you invest in is much easier. Through our extensive (and sometimes grueling) due diligence process, we search for companies with little debt, strong competitive advantages that lead to top market-share, and great management teams.
We have been writing for the Canton Repository for more than four years, and one aspect of our investment philosophy that we have not mentioned in great detail and is often overlooked by investors, is predictability.
If you can invest in a company that has predictable recurring revenue it reduces the risk of the general ebbs and flows of the economy. Some examples of predictable sources of revenue can be attributable to after-market sales of mission-critical components or software.
Recent examples include JP Morgan Chase offering free trading to their premier checking account customers or Amazon offering additional services to their customers for an attractively low price. All of these strategies strive to increase the predictability of sales.
The automotive sector includes the car manufacturers such as Ford (F), General Motors (GM), Toyota (TM), and others. Investors may also want to consider investing in the companies that supply many of the widgets, seats, sensors, and parts that go into our cars and trucks.
One of the more interesting suppliers is Sensata Technologies (ST). In 2006, Bain Capital, formerly led by former Presidential candidate Mitt Romney, purchased the sensor and controls division from Texas Instruments (TXN) for $3 billion.
Bain Capital is a private equity company who focuses on streamlining operations and providing additional capital to the company to accelerate growth. Through this process, Bain Capital was able to shift their manufacturing to low-cost centers in the world and improve upon their processes for innovation.
The sensors and controls that Sensata manufactures are used in most vehicles, and also in aircrafts and appliances. Although these sensors are relatively low-cost they are mission-critical components to the automotive working properly, which is why manufacturers prefer very high-quality sensors. Each refresh of a product model contains more sensors than the prior version which leads to more growth at Sensata.
The mission-critical nature of sensors provide Sensata with healthy profit margins. Because emissions and safety regulations differ by country and are always changing, Sensata rigorously works with manufacturers to engineer new specifications to comply with these constantly evolving standards.
Sensata Technologies represents a predictable and compelling investment, but the merits and risks should be reviewed with your portfolio manager for your individual circumstances.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.