Not all industries are viewed usefully through the capital cycle framework. Some, but not all, cases where the capital cycle perspective fails to predict value accretion are as follows:
Product Complexity Industries, like car manufacturing, have consolidated into oligopolistic structures, yet fail to generate substantial returns for shareholders. This is because the “tit-for-tat” structure of a co-operative marketplace where price levels can be matched by each major participant, becomes much more difficult when products are complex. The product offering of a vehicle includes feature specification, customer financing terms, safety regulations, marketing costs around new launches, and service and warranty. An industry participant can therefore make the product cheaper (reduced price) through more obscure methods, like extended financing terms, lower rates, lower safety scores, gas efficiency, etc. This creates noise in what is happening in the marketplace, prices rising or falling becomes obscured and tit-for-tat competition becomes impossible. When you compare this to a commoditized market, like paper for example, the only real way to compete is the raise or lower the price, which makes “cooperation” between competitors likely.
Political Interference National stakes in businesses also disrupt the capital cycle. When the government becomes involved in the success of a business or industry, it restricts the markets natural ability to reset, clear out under-performers and reallocate resources to the most productive firms. Many countries promote “National Champions” in their airline industries, meaning that the government has a real or implied stake in the ongoing operations of the company. In Europe, this is often to protect jobs, and can be seen in the national airlines. In America, this seems to be happening in the technology sector where securing access to geopolitical strategic assets (rare earths, compute, etc.) is seen as a nation security imperative. The result of this, from an investment perspective however, is that when capacity reaches an oversupplied state, instead of restructuring via reducing capacity, layoffs, etc., businesses pursue the strategy of market share capture - e.g., spending more money to grow its inefficient operations, rather than becoming more efficient. Inefficiency remains perpetually elevated and the opportunity for returns never occurs.
Exceptional Management A leader or management team with unusual ability to allocate capital efficiently is another scenario where the capital cycle fails to predict results. In this example, Bunzl, the British food packing enterprise is used to highlight an example where the management team has an unique ability to add value via bolt-on acquisitions, that the market does not give them credit for. Analysts forecast out the cash flows based on currently operations, but fail to take into account that these acquisitions are continuous and accretive.
Connections
Link Explanation: While the capital cycle is fundamental to understanding buying opportunities in some industries, it is not functional in certain scenarios. The current note explains why.
The Shortcomings Of The Engineering State
Link Explanation: This is in fact a topic discussed in the book at length. That is, the fact that the Chinese market is very difficult to invest in for several reasons. However, fundamentally, all these reasons come back to an overbearing CCP involvement in the market. Either propping up certain industries, building out excess capacity, or outright intervention, as what happened with Jack Ma in 2020.