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Smart Investor: what you need to know about support services

Often overlooked by investors, the support services sector hosts a raft of good quality, attractively priced companies. Smart Investor gives his take on the sector.

 
Smart Investor: what you need to know about support services

Over the past couple of months, I have tipped the shares of a handful of companies listed in the support services sector of the FTSE 350. This sector contains 32 companies and is, in fact, a subsector of the larger industrials sector, which is home to 65 companies.

Among my tips have been Carillion (CLLN.L), WS Atkins (ATKW.L), Travis Perkins (TPK.L) and Interserve (IRV.L).

Historically, the support services sector has been viewed as something of an inbetweener, somewhere between ‘cyclical’ (meaning companies that will tend to move up and down in line with the broader stock market) and ‘defensive’ (companies that are able to perform well even when the ecomony is slowing).

Moreover, support services is often viewed as being too dull to warrant investors’ attention.

A strong year for support services

However, a glance at the track records of many companies in this sector indicates that their earnings are both stable and growing, offering a degree of certainty and also the potential for further growth in future. The sector certainly should not have been overlooked during the past year, in which it has delivered a total return of 29% versus 13.5% for the FTSE 350 index as a whole.

Of course, past performance is no guarantee of future returns, so is now a good time to invest in companies listed in the support services sector?

In terms of profitability, the average return on equity for the sector is highly impressive at 22.5%. The vast majority of companies in the sector are well into the double digits on this metric, which indicates that they are performing well in spite of challenging economic circumstances.

However, the sector price-to-earnings (P/E) ratio of 16, price-to-book (P/B) ratio of 3.6 and dividend yield of just 2.5% are relatively unattractive when compared with the figures for the FTSE 350 of 11.5, 1.8 and 3.5%.

The winners in the sector

This situation calls to mind my recent article on why there are always shares worth buying, since there are a large number of companies performing well in the support services sector, but many are not reasonably priced.

Support services often includes a wide variety of companies whose share prices, returns and performances are relatively uncorrelated. Indeed, companies in the sector often provide very different services. For instance, Travis Perkins is a builders merchant, De La Rue (DLAR.L) prints money, Wolseley (WOS.L) supplies plumbing parts, Aggreko provides temporary power generation, whilst G4S is involved in security and facilities management.

Although all 32 companies provide services, they supply very different products, in very different markets to a very diverse customer base. Therefore, when assessing which sectors to allocate capital to, the companies within support services should always be looked at much more closely, even if the sector appears to be towards the top end of fair value, as indicated by a P/E of 16.

Look out for bargains

This is because there are more likely to be valuation anomalies than in other sectors, simply as a result of it being overlooked by the market. For example, I previously said that the sector has a rich P/E of 16, but companies such as the ones have tipped can be bought on P/Es of less than 12 and, in the case of Interserve, Carillion and WS Atkins, less than eight. This may be the case in other sectors, but not normally to the same extent as in this sector.

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4 comments so far. Why not have your say?

Maverick

Oct 22, 2012 at 12:27

"Performing well but not reasonably priced"? Don't I remember a quotation "knows the price of everything and the value of nothing"?

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Jeremy Bosk

Oct 22, 2012 at 21:20

Support Services contains a great many companies that moved there because, a few years ago, companies in that sector were indiscriminately awarded high PE Ratios. The result is a meaningless ragbag, a sector that is more image than reality. There are good, bad and indifferent companies in it.

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Jayanti Gandhi

Oct 23, 2012 at 18:24

Market is right and therefore low PE of the suggested companies. Why does the author think they are undervalued?.

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Jeremy Bosk

Oct 23, 2012 at 19:29

The efficient markets hypothesis may be true in the long run. In the short run it is often wrong.

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