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We all know that there have been clear winners and losers this year. It’s become a platitude to point out how well tech and pharmaceuticals have done during the pandemic and how difficult it’s been for airlines and retailers, to name a few.
But how much thought have you given to industrials this year?
It’s rare you see much said about ‘industrials’ as a whole, largely because its constituents seldom perform as one. This is a broad and diverse sector, where different companies’ operations and performance can vary widely.
All that makes for some rich stock pickings. It’s worth spending a bit of time getting to know the sector and the companies on offer. Whether you’re looking for growth or value, defensive or cyclical, there’s bound to be something here to suit your objectives.
Broadly speaking, industrials are companies involved in the manufacture and distribution of capital goods.
Those capital goods range from the construction, engineering and building products you might typically associate with the sector, all the way to aerospace, defence and electrical equipment.
As such, the sector is driven by demand from a wide range of customer bases. While we may all at some point require the pest-control services of Rentokil Initial (RTO), for instance, it’s a very different target market for Melrose (MRO), which looks to buy and improve struggling manufacturing companies, and a different customer base entirely that uses Ashtead Group’s (AHT) industrial renting equipment.
And while much of the sector comprises cyclical companies - that is, companies that can be vulnerable to market downturns but perform well when the economy is strong - there are plenty of traditionally defensive industrials as well.
Simply put, this sector hosts a treasure trove of different opportunities. There’s a real mix in here which it may take some time to get your head around, but the rewards for doing so could be ample.
Where to start?
I said before that many industrials are cyclical companies. That’s largely because of the high fixed costs involved in the work they do. Those costs remain high even when the revenue required to pay for them falls.
As such, 2020 hit much of the sector hard. Demand has been down, supply chains were disrupted and factories were either shut or operating at lower capacity.
All that’s making for some interesting value opportunities within the sector.
A case in point could be BAE Systems (BA), a defence, security and aerospace company. Its share price has struggled this year, but the stock’s fundamentals appear solid. Much of its revenue comes from long-term military contracts, while the business invests in new technologies to fuel future growth.
Despite a tough year, it recently became one of the first UK companies to catch up on all the dividends it had cut over 2020.
Encouraging too is its forecast price to earnings (P/E) ratio of 8x, which suggests the stock is trading relatively cheaply. A projected dividend yield of 6.3% is also promising, though this is not guaranteed.
Another to consider is DS Smith (SMDS), a packaging company. The stock certainly has a cyclical element to its business, which means it has suffered this year, but there could be good growth potential here too.
A consumer shift to e-commerce looks set to remain as one of the pandemic’s lasting legacies. That’s good news for DS Smith, whose cardboard boxes provide the packaging that many online supermarkets and delivery services rely on.
And while the company’s share price is yet to fully recover, things appear to be looking up. In a recent statement, the firm said that performance has continued to improve since the start of September, and that they expect to deliver a half-year dividend after cancelling April’s interim payment.
But the appeal of industrials doesn’t lie solely in cyclical, value opportunities.
Spirax-Sarco (SPX), for instance, looks far more defensive. The steam system engineering company hasn’t suffered over 2020 like some - in fact, its share price has risen around 25% since the start of the year.
As a relatively recession-resilient firm, its share price has enjoyed similar leaps to some big-name “growth” stocks while attracting far less attention.
Similarly, you’re unlikely to see a large correlation between Experian (EXPN) and many other industrials. The credit reporting company’s market performance resembles those of the tech giants that have led market rallies this year, with shares up around 20% over the last year. Conversely, a P/E ratio of 31x earnings may seem expensive compared to the rest of the sector.
Rentokil Initial (RTO) has been another to profit over the course of this unusual year, with demand for its disinfection services soaring. But a projected P/E ratio of 35x comes with the same warning signs as Experian’s.
How do I use these companies?
Just as you would when comparing any of 2020’s winners and losers, it’s important you ask yourself what exactly has driven a company’s performance. Is it solely down to this year’s extraordinary set of circumstances? Do the business fundamentals look solid regardless of everything else that’s happened? Within the industrials sector, the answers to those questions are likely to vary from company to company.
For a sector whose key players perform and operate so differently, it may be difficult to know exactly where to start. It could backfire if you’re looking for a cyclical stock and end up getting a defensive one instead. It’s important you do your research and understand the company you’re buying - irrespective of its ‘industrials’ heading.
Once you’ve done that, there’s some real potential here. It’s a sector that includes several FTSE staples - names many of us have heard of but may not fully understand. They might not be as eye-catching as technology or as familiar as financials, but they could be just as valuable to your portfolio in the long run.
Price Earnings (P/E): A valuation ratio of a company's current share price compared to its per-share earnings.
Important information: Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.