Investing in Steel Stocks

The world's economy is built on steel. Globally, an estimated 1.9 billion tons of steel are used annually for buildings, bridges, automobiles, and heavy machinery. Specialty metals have replaced steel in some limited cases, but the long-term demand for steel remains insatiable.

A handful of companies stand out as leaders in the steel industry. The best steel companies have more modern production capabilities and excel at controlling their costs to compete globally.

Best steel stocks

Here are five steel companies worthy of your consideration:

Data source: Yahoo! Finance and corporate websites, current as of Nov. 19, 2021.

1. Nucor

Originally called "Nuclear Corporation of America,” Nucor has been around for more than 100 years and is evolving to make a range of steel and other products for a number of different industries. The company didn't operate its first steel mill until 1969, but it has quickly shot up to become the largest U.S. producer while selling off most of its other divisions.

Nucor uses electric arc scrap furnaces, which are a lot more efficient than the blast furnaces that have traditionally dominated the industry. These electric furnaces are smaller, less costly to operate, and can more easily be ramped up or slowed down based on demand. This has allowed company results to hold up better when steel demand falls.

However, the incumbents haven't stood still, and much of the industry is racing to modernize and better compete with the likes of Nucor. But Nucor has proven itself to be one of the best capital allocators in the business, investing and acquiring when demand is low and valuations are reasonable. It is also a Dividend Aristocrat (at least 25 years of annual dividend increases) and is closing in on achieving Dividend King status (at least 50 years of annual dividend increases).

2. Steel Dynamics

Steel Dynamics was founded by a Nucor veteran and is trying to follow a similar game plan. The company is focused on electric arc mills and has a similarly conservative balance sheet.

What Steel Dynamics lacks is Nucor's track record, which (depending on an investor's point of view) could be a strength or a weakness. There is arguably a bit more risk buying into Steel Dynamics given that there isn't the same history of results to fall back on. But with a market capitalization less than half that of Nucor, Steel Dynamics could offer a better chance to get in on the ground floor of a major growth story.

3. Cleveland-Cliffs

You can't have the steel scraps that go into electric arc furnaces without some blast furnaces to make the original steel, meaning companies such as Nucor and Steel Dynamics will never fully dominate the global market. Traditional steelmakers have been hindered by foreign competition from low-cost producers, especially when selling outside the U.S. The businesses have restructured and streamlined, however, and they’re now safer investments than they were a few decades ago.

Cleveland-Cliffs is one of the more vertically integrated companies in steel. Founded in the 19th century to mine iron ore deposits in the Great Lakes region, it expanded over time to steelmaking and stamping finished products. The company made a bold move in 2020 when it acquired the U.S. steelmaking operations of ArcelorMittal -- in part making sure there was ample demand for its ore but also giving investors broad exposure to the many parts of the steel business.

4. ArcelorMittal

ArcelorMittal is an investment in global growth. The company is a steel powerhouse, forged via the 2006 merger between Europe's Arcelor and India's Mittal Steel. The company makes a wide range of steel products from facilities in Europe, North and South America, Asia, and Africa, and operates iron ore mining projects in seven countries.

The core U.S. production business was sold to Cleveland-Cliffs, but ArcelorMittal remains the primary steel furnace for much of both the developed world and emerging economies where steel demand is expected to be highest in the years to come. Although not as nimble as Nucor or Steel Dynamics -- and more likely to be caught up in cyclical trends -- ArcelorMittal benefits from geographic diversity and a wide range of end markets for its products.

But there is risk that comes with that global reach. For example, the company was forced to suspend its operations in Ukraine in early March due to the Russian invasion.

5. U.S. Steel

U.S. Steel traces its roots back to the Industrial Revolution. The company was formed in 1901 by banker J.P. Morgan to merge Andrew Carnegie’s steel company with other businesses. The years have not been kind to this one-time giant, which has faced a competitive onslaught from foreign rivals and new technologies. U.S. Steel, however, has divested much of its lower-margin international business and streamlined its remaining production, once again becoming a force to be reckoned with. The company has also invested in electric arc steelmaking and is competing against the Nucors of the world on their own turf.

Today, U.S. Steel has operations in the U.S. and central Europe with the capacity to manufacture a variety of steel products and generate billions in cash annually.

Should you buy steel stocks?

Investors on the fence about buying individual steel stocks can get exposure to a range of steel makers and their suppliers through exchange-traded funds, including the VanEck Vectors Steel ETF (NYSEMKT:SLX) or a broader fund such as the SPDR S&P Metals & Mining ETF (NYSEMKT:XME).

Last year, Congress passed a $1.2 trillion infrastructure spending bill in response to the clear need to refresh aging roads and bridges across the U.S. A boost in construction means more demand for steel. Meanwhile, Chinese demand for the industrial metal continues to grow almost 10% annually, and demand in emerging markets is just beginning to accelerate.

More recently, steel stocks have been moving due to the Russian invasion of Ukraine. Some, such as ArcelorMittal, have direct exposure to the conflict. But even those that do not have been affected because Russia is a top-five global steel producing nation. The conflict and the resulting sanctions are likely to create a global supply-and-demand imbalance.

Despite steel’s ubiquity and the constant hunger for more of it, steel stocks have historically been a questionable investment due to the cyclical nature of commodity businesses and the high fixed costs involved in steel production. Investors attracted by the growth potential need to navigate the field carefully and focus on top operators with a track record of making money even when conditions sour.

The paradox for investors during the past century has been that steel is both an essential part of the industrialized world and that the stocks -- due to the cyclical nature of the business and the massive production costs -- have been underwhelming investments.

The risks remain, but today's steelmakers are less tied to economic swings in one region and have found ways to take some of the costs out of the business. The best of them now generate profits regardless of economic conditions. And, with First World infrastructure in desperate need of renewal and emerging economies in growth mode, demand isn't going away anytime soon. For investors comfortable with some cyclicality and looking for stocks to make up the foundation of a long-term portfolio, adding some high-quality steel might be a good move.