The sectors we are trying to avoid and why

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When it comes to investing, we deliberately avoid certain areas that we believe may not be predictable in the long term due to various factors, and can therefore be very speculative.

Take the energy sector as an example. Oil and gas producers offer products that are difficult to distinguish and are subject to macroeconomic uncertainties. It is difficult for us to justify the existence of a moat for most (if not all) energy companies, which is reflected in the volatile return on investment of these companies. In our view, those with the best sources in this area win as the technology continues to improve and spread. The sector is also overcrowded with tons of companies producing significant amounts of oil and gas worldwide.

For those who are enthusiastic about energy, we recommend a look at the service providers in the industry. Companies such as Exponent (NASDAQ: EXPO), which offer technical advice and fault analysis, and ANSYS (NASDAQ: ANSS), which offers simulation software, may give investors a higher chance of achieving long-term value.

Similar to the energy business, we also consider pharmaceutical manufacturers to be highly speculative. Pharma generally relies on patent protection to demand top prices and fend off competition. As a result, these companies can achieve a reasonable return on investment in the short term. However, such a dependency exposes companies to longer-term uncertainty as the patent expires. Shareholders can think of these patented drugs as bonds, but not as a pension. In order to continuously generate free cash flows in the future, pharmaceutical manufacturers must constantly develop new products and bring them to the market. Here we see a significant risk for the pharmaceutical business model, as the value of these research and development pipelines is not only unpredictable, but is also likely to be extremely low. According to a study by the KMR Group, the success rate of a drug in the preclinical stage, which makes it until approval by the Food and Drug Administration, is only one in 10,000.

While the pharmaceutical companies themselves could be a speculative bet, some of their service providers may offer long-term shareholder value with predictable cash flow for those longing for a lucrative and potential healthcare market. One example is Waters (NYSE: WAT), the world's leading specialty measurement company that aims to improve human well-being. The sales risk in the pharmaceutical industry is 60%. Global drug manufacturers such as Bristol-Myers Squibb (NYSE: BMY) and Pfizer (NYSE: PFE) rely on the company's analytical technologies in their research, development and manufacturing processes. Regardless of how successful the research is, Waters makes his money. The majority of this comes from recurring transactions (e.g. consumables and services).

Some other areas that we try to avoid include banking and fashion. The former competes primarily with commodity products with an increasingly complex business model, and the latter often has to adapt to the unpredictable and rapidly changing trends in consumer taste.

Disclosure: The mention of a security in this article does not constitute an investment recommendation. Investors should always carry out thorough analyzes themselves or consult with their investment advisors before entering the financial market. We own shares in Waters.

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