Investment Insider: Be smart over shares as economy recovers

Choose carefully and you may benefit as we come out of recession

No one has yet been brave enough to suggest "green shoots" of recovery, just in case they turn out to be advanced mould. But as private investors we can afford to look a little further ahead than cautious politicians. After all, waiting for a recovery to be fully entrenched before investing might mean having to pay more for our shares. That said, it pays to be cautious.

You would think that as businesses come out of a recession, the future would start to look brighter as profits and cash swell those depleted coffers. However, emerging from a slowdown can sometimes be more perilous than entering an economic downturn. That's because as companies enter recession, they tighten their belts and trim output in line with reduced demand. In other words they downsize and dispose of underperforming businesses to conserve cash. That's the easy part.

The difficulty comes when companies need to cope with increased demand after a recession. Some may find that, as a result of over-prudence, they could be faced with insufficient production capacity and shortage of working capital.

They may also find that better-positioned and better-financed competitors might start to eat away at their share of the market. Consequently, it is important to focus on companies that have adequate working capital.

Banks are an obvious recovery share. If you haven't already noticed, banks have been extra prudent over the last few years, much to the annoyance of the Government. They have been reluctant to lend and instead chosen to rebuild their balance sheets in readiness for the recovery. They understand better than most that economies cycle through booms and busts. They were badly wounded by the downturn but are also best positioned for a recovery. Banks are also in a good position to cope with the eventual interest rate rises. They will simply pass on the higher cost of borrowing to their customers. The UK's largest banks, including HSBC and Barclays, are expected to post higher profits this year and next.

House builders are another sector that could emerge stronger from recession as demand for new homes improves with rising consumer sentiment. According to figures from the Council of Mortgage Lenders, gross mortgage lending in the first three months of this year, although down significantly from its peak in 2007, has been on the rise over the last three years. Persimmon, which was recently promoted to the FTSE 100, and Barratt Developments are both expected to report respectable increases in profits over the next couple of years.

An end to recession may also see a rise in demand for commercial office space as businesses dip a tentative toe into expansion. London-focused Workspace Group is a Real Estate Investment Trust, which means that it must distribute at least 90 per cent of its income as dividends to shareholders. Profits are expected to be flat next year but they could bounce higher the year after. In the meantime, investors could enjoy a dividend yield of around 2.7 per cent. Regus provides flexible workspace for businesses not only in the UK but around the world too. Profits were hit badly following the financial crisis. However, its recovery has been almost as spectacular as its deterioration. Profits are expected to return to pre-crisis levels within the next two years.

David Kuo is director of fool.co.uk

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