This article is excerpted from Tom Yeung’s Profit & Protection newsletter dated Aug. 11, 2022. To make sure you don’t miss any of Tom’s picks, subscribe to his mailing list here.
In 2012, I made 300% returns in the stock market without really trying.
It happened again in 2020…
And then again in 2021…
I bought companies in consolidating industries.
For 2012, it was the airline industry. Ammunition in 2020. And coal in 2021.
In each of these cases, a “terrible” industry would see profits rise 5x… 10x… 20x… after bankruptcies, liquidations and mergers left the industry with few remaining players. It’s a wellspring of easy profits.
The strategy only works every several years; industry consolidation doesn’t happen all the time.
But when it does happen, investors can outperform the market. And today, one new industry is teasing 300% returns. Read on to find which one.
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Exploiting Inefficient Markets
The reason for airline outperformance was simple:
Markets are efficient vehicles for gathering consensus market views…
…but consensus views are sometimes slow to change, especially with consolidating industries.
In the case of airlines, investors “knew” it was a terrible industry.
“For 100 years, airline transport has not been a good business,” Warren Buffett said in a 2013 interview on CNBC. “A seat on an airliner as a commodity to a great extent.”
But managers with billion-dollar funds often can’t see the changes that you and I do. The tight-fisted Mr. Buffett flies around in a private jet he once named “The Indefensible.” And how would an analyst sitting in Wall Street’s glass buildings (as I once did) know the price of a gallon of milk? Even I almost missed the rise of airline fares.
Yet, these Wall Street blind spots create enormous buying opportunities.
- Railways. Companies like Canadian Pacific Railway (NYSE:CP) rose +600% between 2009-2014.
- Ammunition. Bullet-maker Vista Outdoors (NYSE:VSTO) jumped +550% between 2020-2021.
- Coal. Near-bankrupt miner Peabody Energy (NYSE:BTU) skyrocketed +900% between 2021-2022
In each of these instances, a “Main Street” industry would suddenly become a superstar winner because of one word:
In the case of airlines, mega-mergers between top players meant that the top 4 carriers controlled two-thirds of the industry by 2013. Delta (NYSE:DAL) would make up 80% of all flights from Atlanta’s Hartsfield-Jackson airport that year.
In rail, these same forces would turn a struggling industry into one of America’s most profitable sectors. Only seven Class I freight railroads exist today, down from 33 in 1980. And concentration in specific sectors is higher; two railroads now originate 65% of all U.S. grain.
These changes are apparent to anyone who works in the business. Try to buy ammunition at your local gun store, and you’ll have a choice between two manufacturers. Shells now easily cost over a dollar per round. And at the grocery store, our choice of meat and prepackaged bread is an illusion. 2-3 companies now own dozens of brands on store shelves.
Observant investors will notice these things in everyday life.
Meanwhile, outsiders on Wall Street are often slow in responding to these tectonic shifts, especially when they’re happening far away from the glass high-rise offices of Manhattan or Omaha.
Beating the Street at Its Own Game
There are three ingredients to these hidden gems:
- A “Hated” Industry. A history of low returns, poor growth and high capital requirements will set the stage for cheap stock prices.
- Consolidation. Mergers, acquisitions and bankruptcies that give the remaining players pricing power.
- Essential Goods. Sectors that produce goods that are difficult or impossible to substitute.
And today, one sector stands out as the next big winner:
From Four to Three
Ask any Wall Street investor about telecom, and watch them respond with a mix of apathy and disgust. The iShares Global Communication Services ETF (NYSEARCA:IXP) has risen just 7% since 2005, underperforming every other sector of the Global Industry Classification Standard (GICS).
There’s a good reason for the dismal performance. For years, America’s telecom firms have fought in a seven-way battle. The two top players AT&T (NYSE:T) and Verizon (NYSE:VZ) competed against upstarts Sprint and T-Mobile (NASDAQ:TMUS), along with smaller players Leap, MetroPCS and U.S. Cellular (NYSE:USM).
It was a recipe for disaster. High capital expenditure, changing technologies and a massive country to cover meant that firms like Verizon could sink $20 billion per year since 2000 into capital investment and still see end-user prices stagnate.
Put another way, my $40-per-month cell phone bill had barely budged in the 20 years leading up to 2020
But that also gives telecom the perfect setup for 300% gains.
Since 2011, the number of wireless providers has shrunk from seven to four. And with U.S. Cellular’s market share dropping to 1%, the wireless industry has become a three-way race.
Prices have already started creeping up. The cheapest plan from T-Mobile for a single line now costs $70 after taxes and fees, reversing years of price declines. According to the BLS, spending on cell phone services finally stopped falling in 2020.
“A stable competitive market never has more than three significant competitors,” BCG founder Bruce Henderson noted in 1976. The “rule of three” eventually makes it “neither practical nor advantageous for either competitor to increase or decrease share.”
In other words, telecom is no longer a race to the bottom.
Which Telecom Stock Should You Buy?
So, why do I say investors can make 300% with virtually no effort?
That’s because there’s no need for fancy 3-stage DCF models…
…Complicated intrinsic value calculations…
…Or reading the tea leaves of management guidance.
That’s because when industries consolidate, all companies gain.
For airlines in 2013, investors could have easily made the same high returns on Southwest (NYSE:LUV), United (NASDAQ:UAL) or Hawaiian (NASDAQ:HA).
Similarly, telecom’s three remaining players – AT&T, Verizon and T-Mobile – all stand to profit. Even though Profit & Protection has highlighted AT&T for its cheapest starting price, the trio all provide the same essential wireless services, and all have begun flexing their oligopolistic pricing power.
Bottom line: buy AT&T if you only pick one telecom, but all three should outperform over the next decade.
Some Patience Required…
Consolidation plays are phenomenal for their high batting average and relative safety. AT&T has a 6% dividend yield, one of the highest rates for a blue-chip stock.
The strategy, however, can take years to play out. Freight railroad CSX (NASDAQ:CSX) took over a decade to rise 10x.
That means high-frequency traders are better off buying high-beta momentum stocks listed in Tuesday’s newsletter. But if you are willing to wait for returns without really trying, then AT&T and the telecom industry provides a stunningly attractive play.
Tom Yeung is the editor of Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad. To join Profit & Protection — and claim a free copy of Tom’s latest report — go here to sign up for free!