The manufacturing sector is an important component of a diversified investment portfolio. However, with the cyclical nature of the wide range of companies that fall under the manufacturing umbrella, it can be difficult to choose the appropriate stocks to own.
Many manufacturing companies do not enjoy widespread name recognition among individual investors. This is because their products aren’t household items and they often do not sell their goods and services to individual consumers. The obscure nature of some of the sector’s participants combined with the cyclicality of the sector make it especially difficult to pick winning stocks in the manufacturing sector.
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Like all sectors of the market, there are sub-sectors of the manufacturing sector. Even though the sector is a cyclical sector, some companies rebound more quickly than others. These companies are commonly referred to as growth cyclicals. Growth cyclicals are very prone to price fluctuations; however, they continue to grow. They are also well diversified, have new products and advanced technology. On top of superior performance, growth cyclicals also offer superior dividend payouts and regular dividend increases. Examples of some growth cyclicals are 3M (MMM), Ecolab (ECL), General Dynamics (GD) and Illinois Tool Works (ITW).
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There are several significant benefits to owning manufacturing stocks. First, industrials benefit more than other sectors during periods of economic growth. Second, manufacturing stocks provide diversification and income for investors. This means that during the eventual economic rebound, we can expect the manufacturing sector to see more dramatic gains than other sectors and that the increased profitability will also result in increased dividends.
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As with any investment, there are risks associated with investing in the manufacturing sector.
In the current market context it is especially important to note that the profitability of the manufacturing sector is closely tied to the growth and expansion of the United States economy. Based on our current economic situation, some analysts are expecting continued market fluctuations before we enter into a period of sustained economic expansion. This means that you must be patient when buying into the manufacturing sector because the value of your holdings will most certainly fluctuate. The manufacturing sector is so sensitive to economic upturns and downturns that values have tended to fluctuate by more than 50 percent.
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The second major risk applies to manufacturing companies located within the United States economy. To the United States’ manufacturing sector, the rising threat of low-cost, foreign competition is a growing risk. China is a prime example. The rapid emergence of China as a manufacturing base, where labor is significantly cheaper than in the United States is the driving force behind the Chinese manufacturing threat.
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The third risk facing the manufacturing sector, in general, is growing protectionist sentiment. Many countries around the world are considering a narrowing of international trade as a result of national stimulus policies and political pressure at home. If protectionism takes hold in any significant way, that would be a serious blow to the manufacturing sector.
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The final risk facing the sector is that in several major economies, employers are facing an aging workforce and this means increased pension and medical liabilities. This will drive up costs for Western manufacturing companies making it even harder to compete with their Eastern rivals.
While there are certain risks facing manufacturing companies, buying stable companies with consistent dividend records is a safe way to gain the necessary exposure to the sector. The companies with consistent dividends that are well diversified are an excellent addition to any well-balanced portfolio.
An investment in a manufacturing company can experience significant profit, however, manufacturing investments can also experience significant losses. To alleviate the loss potential of a manufacturing investment, investors can use stock options. Stock options can provide portfolio insurance. A put option is similar to auto or home insurance, if something catastrophic happens the position is protected. Investors can also generate monthly income with stock options, and combining a monthly income strategy with a protected strategy can result in profits with very little risk. There are a plethora of stock market books about investing, but the problem with these books, is they focus on the profit potential and not as much on the potential risk. A good protective put option strategy considers risk first and then potential profit second. Manufacturing stock appear to be very well suited to a protective put option strategy.
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[tags] manufacturing, cyclical, ECL, ECOLAB Inc., GD, General Dynamics Corp., ITW, Illinois Tool Works Inc., MMM, 3M Co. [/tags]