In an earlier post ("Market Cycles and Sectors") on Dec 1, 2008 the sectors that receive prominence during different stages of the economic and stock market cycles were discussed.
Does that mean that you, as a small investor, should look at investing in all those sectors? Probably not.
Fund managers, who are under pressure to perform in the short term, have no alternative but to move in and out of sectors depending on the particular stage of the stock market. They also have access to company managements and better research resources and larger funds than small investors.
With considerably less funds and little or no research capabilities, small investors like you and me are better off choosing only a handful of sectors to invest in.
Some industries are in an environment that helps to create substantial competitive advantage. It is easier for the companies in such industries to make money.
Four sectors that I like - based on their competitive advantage and cash generation capabilities - are :-
1. FMCG: Strong brands built up over the years create huge competitive advantage. Companies tend to be solidly profitable, debt free and generate a ton of cash (which is distributed to investors through generous dividends). The market leaders have been around for many years, so they are slow but steady performers.
This sector is practically recession proof and should form a significant part of a small investor's core portfolio. Companies to look at are HUL, ITC, Colgate, Nestle, Brittania, Dabur, Marico.
2. Pharmaceuticals: Like FMCG, Pharma companies are recession proof, have strong brands, are hugely profitable and good dividend payers, and long term growth is assured because of the large population. MNC Pharma companies have access to better product pipeline from their overseas parents. Domestic Pharma companies profit from generics and contract research and manufacturing.
This sector should also receive pride of place in your portfolio. Companies to look at are Glaxo Pharma, Aventis, Sun Pharma, Lupin, Glenmark.
3. Financial Services: Banks pay less interest to depositors and lend the money at higher interests. For current account holders, banks pay nothing at all. Many make more money by selling other financial products to their customer base - such as insurance, demat accounts, credit cards, mutual funds, home loans. Home loan companies tend to be highly profitable with long term growth assured.
Companies to look at are State Bank of India, Bank of India, HDFC Bank, Axis Bank, HDFC, LIC Housing Finance, Sundaram Finance.
4. Media: Many companies have competitive advantage through regional language and regional market domination. This sector also tends to be recession proof.
The dynamics of the media business was covered in an earlier blog post on Sept. 8, 2008.
Are these the only sectors that an investor should look at? Obviously not. But this should be a good starting point in building a long term portfolio.
Future posts will cover other sectors and criteria for individual stock selection.