A Dinner-Game Loss Taught Me the Importance of Understanding Industries

It was my friend's daughter's idea.

"Let's get all the kids together and play a game, Food Network-style!"

The rules were pretty simple: participants were given specific ingredients — a mix that didn't obviously go together. The "chefs" had 30 minutes to make a meal. The judges, in this case the youngest kids, would disqualify the "chef" who made the worst meal, taking away the chance to participate in the dessert round.

Here's how it played out:

Ingredients: Pasta, sausage, carrots, cheese, and to mix it up, chocolate

Time: 30 minutes on the clock

Results: Variations of pasta with cheese sauce, fried sausage and sprinkled chocolate (yes, ewww!)

Winners: Not my kids!

Over the years, little exposure to cheese, beyond pizza, resulted in a lack of ingredient knowledge for my kids. While their competitors were grating, melting and mixing, my kids were scrambling. They had no idea what to do with it.

It was a reminder about the importance of knowing key ingredients, which also holds true to investing. Just like cheese was a core ingredient of our cooking game, industries are often a key consideration when it comes to choosing investments.

When considering a new-to-us industry, we often either don't know enough about it — which was the case in the dinner game — or we have a narrow world view based only on our experiences (think all cheese singles, all the time!). Peeling back the layers of an industry to truly understand how it works at both a product level and in a larger context can help determine whether or not it might fit our portfolio mix. Not only can it be worth the time, it can also expand our world view.

To put this concept of knowing the industry into practice, here are some basics to consider:

Industry Structure: Some industries may appear the same but in reality are very different based on how they are structured and what sub-sector of the industry they generate revenue from. Statistics Canada offers a deep dive into 20 sectors of the Canadian economy, with breakdowns of the number of businesses involved in a particular industry, gross domestic product data and financial performance details, for example. That could be one place to start. You could also view the performance of Sectors & Industries in Canada and the United States.

Product Buyers: Consider the customer base. Is it only a handful? Millions? It depends on the company, of course. When it comes to cheese, there might be a more limited number of buyers in the hand-crafted cheese market, but a much larger cohort when it comes to grocery-store cheese. Keep in mind that when a small number of customers are responsible for a large number of sales, no matter what the industry, the loss of each customer could have a bigger impact.

Market Share: To understand players in the industry, consider a company's market share, or the portion of sales it captures in the market. Is there one large player? If yes, has that player created a sort of economic moat, or competitive advantage, by clearly outpacing all the other companies that might help to protect its current or future holdings? Doing research can help you explore what that might mean for your portfolio based on your goals and current asset mix.

Growth Stage: There are different stages of growth for industries that may help classify them. A growth industry, for example, may expand at a faster rate but is perceived as having an above-average risk. These companies often finance much of their expansion and generally do not pay large dividends, if at all. Mature industries may have growth that more closely matches the overall rate of economic growth, which may mean slower, more stable growth rates for companies. Declining industries can mean companies' profits are affected due to the decline, often as a result of new technology or changes in customers' interests.

Regulatory Moves: Industries can be subject to regulations (environmental, safety, trade, etc.) that can greatly impact their overall growth, which can then filter into specific companies within those industries. Researching just what an industry may be facing can help us understand the issues.

Post-game strategy

As a newly found hyper-competitive food gamer, I decided to create a post-game strategy to expand the cheese lexicon in my house. We started with grilled cheese. Quickly it became the gold standard, but of course there are hundreds of other cheeses and configurations out there. Those will need to be introduced over time...after some research, of course!