INVESTMENT STRAGIES - SECTOR ANALYSIS

Sector Analysis.

Source: Investors Chronicle

A Top-Down strategy identifies the promising sectors and selects the best stocks within
the sector using the chosen criteria.

Automobiles
• Unemployment and interest rates have a negative impact on car sales.
• Like Utilities, Automobiles is good for Dividend Yield. Sell on Dividend cuts.
• Some value stocks are available at a 60-80% discount to market PE. Sell when
they fall back to the 20-40% discount range.
• Growth opportunities exist in increased content per vehicle – electronics and new
technologies.
• Invest in companies with high Margins since they are better protected against
cyclical downturns.
• Avoid companies with low liquidity since institutional money pushes the share
price.

Chemicals
• Avoid a ‘buy and hold’ strategy.
• Good management is crucial in this sector.
• Chemicals is capital intensive so look beyond EPS.
• Avoid cheap stocks, which usually means bad in this sector.

Luxury Goods
• Strongly linked to good macro-economic environment and equity markets.
• It is a fragmented market with pressure for consolidation.
• Control over distribution gives a competitive advantage.
• Japanese are the single biggest buyers of luxury goods.

Transport
• Airline stocks with low PEs are a sell. High airline PEs are caused by lower
earnings, which exist around the bottom of a cycle. Therefore, good time to buy.
• Americans stop travelling abroad at the slightest excuse.
• Transport companies are very sensitive to GDP growth.
• Pay particular attention to a company’s net cash position.

Banking
• Look for strong CEO leadership.
• Check out ROE, Cost/Income Ratio and the success of expansion moves.
• Problem banks are usually worse off than the figures indicate.
• In an environment of consolidation, look for a well-positioned bank.

Leisure
• Leisure spending is one of the first to go in an economic downturn.
• Cost of refurbishment is an important factor.
• Rising property values can be a benefit.
• Legislative changes can affect the sector.


Biotechnology
• Management is the key. The product is only half the story.
• Keep an eye on the news flow, which contributes to the volatility.
• Ensure a large enough Market Capitalisation and adequate liquidity.

Innovative Therapeutics
• Invest for the long term.
• Invest only between the first confirmation of the product’s potential and its
market approval.
• Astute management is needed.

Energy
• Cyclical sector.
• A contrarian position can be useful.
• Disciplined management is essential.
• Avoid being seduced by alternative sources of energy.

Utilities
• Utilities usually have spare cash. Watch how they spend it. Best if it is invested in
the core business.
• Equally good if they return cash to shareholders through special dividends or
share buybacks.
• Invest in utilities that are restructuring.

Enterprise Software
• A shortfall in revenue targets is usually disastrous and can mean a 50%
correction.
• One profits warning tends to lead to another. However, buying an established
company on a 50% correction can be a winning strategy.
• Beware if the story sounds too good.
• News flow impacts significantly on prices.
• It has a strong correlation with movements in the Tech sector.

Tobacco
• Usually provides a strong and predictable cash flow.
• Litigation has introduced volatility.
• Profits warnings are rare. When they occur, the problem could be serious.
• Select multi-national producers with strong brands.
• Demographics are important e.g. a younger population.

Biotechs
• Phase II or Phase III is potentially more lucrative and the risk is lower than at
Phase I.
• Are there any issues with safety or efficacy that could hold up the drug's route to
market?
• The trials should meet the requirements of the US Food and Drug Administration
as well as European medical regulations.
• FDA Orphan Drug status can speed up the development process if there is no
existing treatment in the market.
• Interest from big pharmaceutical companies gives more credence to the
company's technology and offers the potential for revenue from milestone or
upfront payments. The further along the clinical trial process the drug is, the
bigger the payments because more of the risk is taken out of the equation.
• It is no good having a great product, but no cash to pay for the development.
• Check for cash burn and overheads. Find out if the company is living beyond its
means or has it attempted to cut costs.
• Some biotechs sprang from academia and are headed by scientists who may be
too close to the research and unable to judge the commercial potential.
Management experience is desirable.
• Having experience in dealing with big pharma helps in seeking to clinch lucrative
licensing deals.
• Select companies with existing revenue streams and a range of drugs or products
in its pipeline.

Defensive Stocks tend to hold up in a bear market.
The sectors are:
• Pharmaceuticals
• Food and Drink
• Supermarkets
• Tobacco
• Utilities

Shares like Tesco and GlaxoSmithKline should be long-term core holdings.
Some defensives should be retained for their good dividend yields.

Cyclical/Recovery Stocks tend to outperform when the economy recovers from
recession.
The sectors include:
• Engineering
• Chemicals
• Mining
• Media
• Transport
• Retailers

Highly Cyclical.
Automobiles
Chemicals
Construction
Electronic Equipment
Forestryand Paper
General Retailers
Information Technology
Insurance
Leisure and Entertainment
Media and Photography
Oil and Gas
Restaurants and Pubs
Software Services
Support Services
Transport
























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Non-Cyclical.
Beverage
Electricity
Food Producers
Food and Drug Retailers
Gas
Healthcare
Household Goods
Pharmaceuticals
Telecommunications
Tobacco
Water