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Do dying industries make good investments?

I recently watched this video made by Ben Felix.

In the video he argues that based on the historical data it is a bad idea to invest into exciting new technologies, and the companies that create them. Historically investors have overestimated the future growth of new innovative firms and underestimated how long it would take for dying industries to become irrelevant.

From 1900 through 2019, rail companies declined from a 63% share of the US stock market to a less than 1% share. It is the ultimate example of a declining industry. Over that time period, rail stocks beat the US market, road transportation stocks, and air transportation stocks.

Ben Felix, 2020

To illustrate the point, Ben uses the example of the declining rail industry. Despite going from a 63% to 1% share of the stock market capitalization between 1900 and 2019, it still managed to outperform innovative new transportation technologies like cars and airplanes during the same time period.

Investors had overestimated how quickly the railway companies would become obsolete leading them to value those stocks too low. Similarly, they overestimated how well car and airplane companies would do causing those stocks to become overvalued and have lower returns.

The moral of the story is that great companies are not necessarily great investments if you pay too much for them, and when new technologies come out investors get excited and do just that. Additionally, bad companies could be good investments if you can get them cheap enough.

Since the approximate start of the age of information in 1971, the software industry has grown more than any other, from basically non-existent in 1971, to the largest industry by market capitalization at the end of 2019 at nearly 15% of the US stock market. The oil industry on the other hand has seen a massive decline in market capitalization, from nearly 15% of the US market in 1971, to about 3% at the end of 2019. Over this period, a dollar invested in the oil index grew to $134, while a dollar invested in the software index grew to $76.

Ben Felix, 2020

A second example is that you would have made more money holding oil stocks instead of technology stocks over the time period between 1971 and 2019. Most likely investors are overestimating how quickly renewable energy will make oil obsolete leading to oil stocks being undervalued and having higher returns.

So counterintuitively, it seems like you’re better off investing in cheap dying stocks over expensive growth stocks. In other words, values stocks (those with low multiples) outperform growth stocks (those with high multiples). This is a well known phenomenon called the value premium and is the basis for value investing.