There are several indicators an investor can watch for in order to spot turns in an industry’s capital cycle.
Competition Exiting
One of these is the throwing in of the towel by a competitor in the marketplace. This most often occurs in periods of extreme stress where capital cannot be secured to maintain operations through demand downturns. If investors are willing to take a multiyear perspective, leaders in the industry with great prospects and fundamentals can often be found at discounted pricing as pessimism is high and one business failing can spread that pessimism into surrounding firms.
Depreciation to Cap Ex Ratios
Another sign of the capital cycle rotating is the change of the depreciation to cap-ex ratio for industry participants. When Cap-ex begins to diminish in proportion depreciation, it is a sign that the cash flows require for supply build out are in their final stages and that the industry is entering into the harvesting phase where infrastructure will be used to meet demand. Cash flows into assets will decrease, meaning free cash flows available to shareholders will increase.
Simultaneously, the opposite is true. When the depreciation to cap-ex ratio is inverting, so that cap-ex is growing in proportion to depreciation, it is a sign that free cash flows are to be diverted away from shareholders in order for the business to remain competitive.
Connections
Capital Cycle Purchase Candidates
Link Explanation: The linked note discusses how to assess the viability of a firm for investment within the capital cycle approach. The current note provides indicators for the best time to buy into the industry. By combining the two, the investor can find a great business at the right time to maximize future long term results.