This column, like most, tends to adhere to the bottom-up approach to investing: pick a share that looks cheap on a few fundamental valuation criteria, and don't worry too much about what industry it's in. The alternative is to take a top-down approach: pick out a few attractive industries, and then limit your buying to those sectors of the market.
That approach can be very rewarding, as a glance at the table shows. The bull run in large companies meant that you could hardly have gone wrong with banking, pharmaceutical or utility shares last year. Similarly, the strong pound and weak commodity prices meant most investments in the paper and packaging, diversified industrials or mining sectors would have left you a lot poorer. With that experience in mind, we decided to pick our three favourite sectors for the coming year.
Despite a storming performance last year there is still plenty to go for in the banking sector. Analysts are still predicting strong earnings growth. The retail banks still have plenty of scope to grow margins by cutting costs as they continue to slim down their branch networks. The promise of further consolidation in the sector is also likely to buoy share prices.
Support services also enjoyed a great 1997 and with most stocks sitting on a p/e ratio of more than 30 the sector is not cheap. However, there should be more growth to come. The outsourcing market is still expanding rapidly with more companies farming out anything from distribution to administration to third parties.
Our third choice is the transport sector, which underperformed the market last year but should bounce back in 1998. Bus and train operators were hit be fears that the Labour Government would seek to clamp down on profits by imposing tough new regulation. However, the industry has enjoyed a strong rise in passenger numbers and should actually benefit from the Government's focus on public transport.
British Airways and BAA will continue to cash in on the strong growth in airline custom and the other big player in the sector, P&O, is finally turning the corner after securing a flurry of mergers.
But there are sectors to avoid. Industrials do not look attractive. The damaging effects of the strong pound will really begin to bite this year and the full effects of the financial turmoil in the Far East have yet to be seen. Aerospace stocks should benefit from strong orders and the continued restructuring of the industry throughout Europe but prospects for exporters generally look poor with further earnings downgrades probably on the way.
The outlook for the media sector is also uncertain. The proliferation of new channels with the onset of the digital television age will lead to intense competition for advertising revenues. The costs of setting up the new services will also dampen earnings growth.
Also steer clear of oil stocks. The world oil price looks set to remain weak for the next two years. And, apart from Shell, most companies have already done the bulk of their cost-cutting.