Over previous decades some of the most attractive investment ideas have been businesses that offer households essential services. Reliable cashflow, decent dividends and growth were all on offer.
However, these days I think many essential services are not good investments. Just because many households use energy, telecommunications, supermarkets and banks does not make them good investments these days.
For starters, nearly all of these essential businesses have reached the market saturation point. They already command as much as the market as they naturally can, and the ACCC is unlikely to let them buy a large competitor. If little market growth is on offer then there are much fewer avenues to expand the business.
In the past households were experiencing strong income and wealth rises. These days many household budgets are a lot tighter than before. Any business trying to increase prices comes under enormous social and political pressure. I don’t like owning businesses that struggle to increase prices.
AGL Energy Ltd (ASX: AGL), Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC) and other big banks are great examples of this. Energy companies are having to reduce prices slightly after sustained complaints around prices. The banks are increasing interest rates but at a heavy reputation cost.
Most essential services are now seen as commodities. It is easy to compare loans or energy on comparison sites. There is not much of a moat against competition. That’s one of the main reasons why Telstra Corporation Ltd (ASX: TLS) is struggling so much, there are a plethora of smaller competitors offering better value data deals.
We have already seen what has happened to Woolworths Group Ltd (ASX: WOW). Aldi has grown and offers better value prices, so Woolworths has had to lower prices to bring back customers. I expect its margins may slowly fall to be closer to similar peers in North America and Europe.
The essential service shares on the ASX offer little growth and also face growing competition. I do not think they are capable of delivering good returns over the medium-term, which is why I don’t own them in my portfolio.
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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.