Capital Goods Stocks: What They Are and Why to Invest Wisely

Certain products are meant for consumers' use, while some are required to make goods. This is the simplest explanation of our topic today— “Capital Goods Stocks”.

This Industry accounts for 12% of India's total manufacturing output and approximately 1.8% of the national GDP.

It employs more than 1.4 million people!

Finding it interesting?

Let’s explore this “heavy” industry in detail-

What are Capital Goods Stocks?

As the global economy rebounds from the pandemic, capital goods stocks have become a strong theme for equity investors seeking solid returns.

These stocks have outperformed benchmarks like the S&P BSE Sensex and Nifty 50, with many delivering multibagger returns.

Capital goods include assets like buildings, machinery, and equipment used to produce other goods or services.

Unlike consumer goods, capital goods are durable items used in production, though some, like airplanes, can also be consumer goods.

Some Examples of capital goods?

● Factories or machines used to build cars

● Technology for manufacturing

● Infrastructure like trains or broadband lines

● Coffee machines in cafes

● Delivery vehicles used by companies

Capital Goods Sector in India

The capital goods sector, also known as the industrials sector, includes companies that manufacture or distribute machinery, electrical equipment, aerospace, defense, engineering, and construction materials.

This sector is vital to manufacturing, contributing 12% of India’s manufacturing output and 1.8% to GDP.

Its total market size is $92 billion, and production is valued at $32 billion. It currently employs 1.4 million people, and this number is expected to increase to US$115.17 billion by 2025.

Despite its potential to grow to INR 7 lakh crore in the next 4-5 years, the sector is facing low demand both domestically and globally. Key export areas include heavy electrical equipment, mining machinery, and process plant equipment, making up 85% of India’s capital goods exports.

To boost local manufacturing, IIT Madras has launched an advanced manufacturing technology center, working with the industry on smart manufacturing solutions.

The sector’s target production size is $115 billion by 2025, with the electrical equipment industry expected to reach $100 billion and the T&D segment $75 billion.

The sector's order book grew 9% in the first half of this fiscal, with a 14% year-on-year increase in FY22.

Why to Invest in Capital Goods Stocks?

Global Trends

Global economic growth: The pace of global economic growth impacts demand for capital goods. Strong growth leads to more investment in infrastructure, manufacturing, and technology, increasing demand for equipment.

Technology and innovation: Advancements like automation, AI, robotics, and 3D printing are reshaping the capital goods sector and changing what’s in demand.

Global supply chains: Supply chain disruptions, trade tensions, and sourcing changes affect costs, production times, and competition for capital goods companies.

Sustainability and environmental initiatives: Growing focus on sustainability and renewable energy is driving demand for green technologies and energy-efficient equipment.

Urbanization and infrastructure development: Population growth and urbanization boost demand for infrastructure, benefiting companies that provide construction and equipment.

Geopolitical events and trade: Geopolitical shifts and trade agreements impact international trade and market access for capital goods companies.

Health and safety: Increased focus on workplace safety and ergonomic designs drives demand for specialized machinery and equipment.

Analyze Economic Cycles

The capital goods industry is closely tied to the broader economic cycle, making it a key indicator of economic health.

This industry includes the production of goods like machinery, equipment, and infrastructure, which businesses use to manufacture products or provide services.

Its performance fluctuates with economic conditions, so understanding this cyclical nature is crucial for investors.

During economic growth, businesses increase spending on capital goods to boost capacity, leading to higher demand and profits in the industry.

In contrast, economic downturns see reduced investments as companies cut costs, lowering demand for capital goods.

Key Factors for Investors:

Economic Expansion: After a recession, companies often invest in new equipment, boosting demand for capital goods. Watching capital expenditures in financial reports can signal growth in the sector.

Interest Rates: Lower interest rates encourage borrowing and investment in capital goods, while higher rates can reduce spending. Central bank policies offer insights into future demand.

Technological Advances: New technology can shorten replacement cycles, spiking demand. Keeping up with innovations can help predict market shifts.

Global Supply Chains: Trade policies and tariffs can impact the availability and cost of capital goods, so monitoring international trade is important.

Sector-Specific Cycles: Demand for heavy machinery in construction, for example, follows real estate market trends. Diversifying investments across sub-sectors can reduce risks.

By understanding these factors, investors can better time their investments and take advantage of opportunities in the capital goods industry.

Government Policies

Infrastructure spending: Government investment in transportation, utilities, and public works directly impacts Capital Goods companies. More spending on infrastructure increases demand for equipment, benefiting the sector.

Trade and tariffs: Trade policies, tariffs, and restrictions can affect the import/export of capital goods, disrupting supply chains, raising costs, and influencing company competitiveness.

Regulations and compliance: Safety and environmental regulations can add costs and affect profitability. Changes in these rules can create challenges or new opportunities.

Tax policies: Corporate taxes and incentives can shape investment decisions and profitability for companies in the Capital Goods sector.

Government incentives: Subsidies and incentives, especially for industries like renewable energy, can boost demand for capital goods.

Political stability: Political changes and uncertainty affect investor confidence and market conditions, introducing volatility for companies in the sector.

Technological Advancements

Constant innovation and technological advancements drive growth and efficiency in the Capital Goods sector. Investing in companies that are at the forefront of innovation can potentially offer significant returns for investors.

Risks in Investing in Capital Goods stocks

Raw Material Volatility:

Raw material prices heavily impact the prices of these goods. Example- Cable production depends on materials like copper and aluminium. Fluctuations in these prices can increase costs and impact profitability.

Technological Changes:

Any major change in the industry can have a sudden and major impact.

As wireless tech grows, demand for cables could drop. The industry must adapt to stay relevant or risk losing business.

Regulatory Standards:

Stricter safety and environmental regulations can force companies to spend more to comply, reducing profits.

The Bottom Line

Investing in top capital goods stocks can be a smart move for those looking for long-term growth. This sector plays a key role in boosting economic growth and benefits from infrastructure and industrial development.

However, investors should consider factors like technology advancements, economic trends, and government policies, as they can affect the performance of these stocks.

Building a diversified portfolio can also help manage the risks linked to capital goods stocks.

Which is your favourite capital good stock?