With excess capacity, profits of a particular business/industry collapse, management is changed & capex is slashed, industry starts consolidation. Reduced investment & hence lower supply, leads to increase in profits. If someone who understands this aspect of capital cycle would be the one to take advantage of change in situation.
Obviously, it requires active investing.
I recently finished reading the book “Capital Returns” by Edward Chancellor, famed author of the book “Devil takes the hindmost”.
The theme of the book is to invest in “Sector which is witnessing capacity contraction and not expansion”. The author makes a point to invest basis on the supply side and not on the demand side of the sector opportunity. The logic behind this is “its futile to determine demand as experts even after trying to predict the demand with so many tools have failed to give even the slightest of the right picture a big margin, both on the lower and upper side. While supply side can be calculated much more accurately by taking into account the capacity of key players in the sector.
I would like to quote a para from the book: “Capital is attracted into high return businesses and leaves them when return fall below the cost of capital.
The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down the returns. Conversely, when returns are low , capital exits and capacity is reduced, over time then profitability recovers.
To validate this point, the author makes a simple example of expansion in global shipping industry led by the increasing Chinese share of global trade which caused the daily rates of Panamax(a class of ships) to rise 10 time between 2001-07. As a result, capacity exploded leading to over capacity & eventually brought down the Panamax daily prices by 90%.
You can read more about Panamax here:Link
Although the author, has lot of credentials and the theory may sound realistic but to invest in the manner the book suggests is Really difficult with a very long holding period. No doubt, when one buys at the time of capacity contraction, the Share prices will hardly anything and one can make load of money but again I repeat its easier said than done.
I personally invest in companies that is expanding its capacity but the capital expenditure for the expansion should majorly come from the companies cash flow rather than debt financing. Fast growing companies can give you hell lot of return in a short time. But again here you need to very cautious as no company can grow at the same pace forever.
The price of the book is a bit expensive at over 3000 bucks and it needs to be imported. Also, while placing the order you would be required to share softcopy of your
ID proof. You can buy the book using the link: Capital Returns
Please comment if you have any query or suggestion.
There is a interview of the author about the book. You can listen it over here: Interview