100 Ways to Beat the Market #5: Avoid Hot Industries with No Barriers to Entry

Editors Note: This is a guest post by Greg Speicher (@greg_speicher), a value investor focused on beating the market. Follow Greg's blog at gregspeicher.com and have a read of his ebook: 10 Ways to Improve Your Investment Process.

A Lex column in yesterday's Financial Times, “Solar: the sun also sets”, is yet another stark reminder that a growing industry does not necessarily make a good investment.

The solar panel industry is expanding rapidly as measured by worldwide megawatts of solar panel shipments. By that measure, business is up approximately sixteen fold in the past five years.

In stark contrast, solar energy stocks, as measured by the Mac Solar Energy Index, are badly trailing the S&P 500. The problem is overcapacity and cheap products coming out of China. One casualty, Evergreen Solar, just filed for bankruptcy protection.

Investors are easily enamored with hot industries with seemingly unlimited growth opportunities. However, in many cases, the businesses in these industries do not have any durable competitive advantages. Competitors pile in and drive margins into the ground.

Society may be the ultimate beneficiary if competition drives down prices far enough for solar power to compete with fossil fuels, particularly if it can be done without subsidies. Investors in this sector may not be so lucky.

Steer clear of hot industries with no barriers to entry. Don't invest in a business without a moat. Pay attention to whether managers gets this and what steps they are taking to strengthen their hand. This may be the single most important factor if you are a long-term investor.