Supply and Demand: Derailing Entire Industries

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It's easy to think of supply and demand as a simple concept you learned in economics that belongs in the "academic information" corner of your brain. Well, it's a lot more relevant to your life and your portfolio than you might think. It can whack or stall entire industries -- and it has.

Real estate realities
Consider the world of real estate. We're not in a prolonged housing slump simply because the economy is bad. Part of the problem has been an oversupply of homes. And when there are more homes available than people are ready to buy, prices are not likely to rise much, if at all.

According to recent estimates from the U.S. Census Bureau and the Department of Housing and Urban Development, sales of new single-family homes have been hovering around 300,000 per month for many months now. As of the end of August, that level represented a ratio of houses for sale to houses sold of about 6.6 months, down from 8.9 last August. The National Association of Realtors has reported the existing-home inventory level falling sharply from between 12 and 13 months last summer to around between seven and eight months as 2011 began, but it's been rising gradually throughout 2011 to 9.4 months as of the end of July. Meanwhile, growing foreclosure inventory is another worry.

So our national inventory glut is still a major concern -- and that has put big pressure on homebuilders such as PulteGroup (NYS: PHM) and KB Home, as well as businesses that thrive from a healthy housing market.

Lights out
Oversupply has been plaguing the solar-energy arena as well, where prices of solar panels have dropped some 70% over the past two years. This has led companies such as Evergreen Solar to file for bankruptcy protection and has caused speculation to grow over which companies will be next to do so. Partly to blame are government subsidies that boosted output, while demand has recently fallen in some markets, such as Italy.

Meanwhile, the remaining companies are struggling. Suntech Power Holdings (NYS: STP) , for example, reported widening losses in its most recent quarter because of inventory writedowns. Trina Solar (NYS: TSL) saw net income plummet almost 70% in its second quarter as soaring operating expenses and other costs ate up a sizable revenue boost. LDK Solar (NYS: LDK) has impressed many with strong revenue growth, but its inventory has been growing, too, and its inventory turnover is low.

Be vigilant
As investors, we'd do well to keep an eye on inventory levels in our industries of interest and also in individual companies. Here are some of the insights doing so might offer:

  • Beverage company SodaStream (NAS: SODA) has won many fans, including our Rule Breakers team, but some might have worried about its 2010 drop in free cash flow. A closer look would reveal that that decline was largely tied to rising inventory, which can be a good thing if a company is prepping to capitalize on growing demand.
  • Inventory at Corning (NYS: GLW) has recently been growing faster than revenue, which is generally a red flag. But a closer look shows that its raw materials are making up a larger portion of inventory. That holds the promise of a bump in future production, as opposed to representing more finished products that might languish in warehouses.

If thinking about inventory seems like a complication you'd rather do without, remember that plenty of companies operate without much inventory at all. E*TRADE (NAS: ETFC) , for example, doesn't have to build stock trades in factories. Still, it is vulnerable to a poor economy, though it has recently turned its fortune around. And eBay lets its sellers maintain their own inventory and simply takes a cut of each transaction.

Despite such exceptions, inventory really matters for many, if not most, companies. Too much can be a potentially good thing, but it can also derail promising industries and excellent companies for quite a while.

Looking for some promising investments?Read this free reportfrom The Motley Fool to find the names of five stocks we own that you should, too.

At the time this article was published Longtime Fool contributorSelena Maranjianowns shares of eBay and Corning, but she holds no other position in any company mentioned. Check out herholdings and a short bio.Motley Fool newsletter serviceshave recommended buying shares of SodaStream International, Corning, and eBay. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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