Where Are The Sweet Spots In The FTSE 100?

I think you can be forgiven for being a bit nervous about investing in the stock market right now. The once ‘safe stocks’ like the supermarkets or banks are no longer a ‘sure bet’, and even those well-diversified companies with an international presence are facing their own challenges. There is money to be made, though, so stick with me and we’ll find out where it is.

This time last year, the British economy was showing real signs of strength. Like many policy makers around the world, though, Whitehall and Threadneedle Street had a tough gig. They needed to work out how to put the economy onto a path of sustainable growth. That meant relying less on the services sector, and finding ways of stimulating the manufacturing and export sectors.

The services sector led the charge right from the start of the recovery. The manufacturing and construction sectors showed some signs of promise in early 2014, but it wasn’t convincing. The latest figures show economic growth in the third quarter of 0.7% (2.8% annualised) and — yep, you guessed it — the services sector is still largely holding up the entire economy.

In terms of the services sector, you’re looking for those companies that have a foothold in your everyday life. Examples include BT Group (LSE: BT-A) and HSBC Holdings (LSE: HSBA). Despite flat revenues, BT has produced a net profit margin of around 10%. BT’s return on assets is also sound — around 7%. And HSBC is one of the better banks from my perspective. It’s got a net profit margin of around 22% and a return on equity of just under 8%. In addition, the bank’s got a competitive price earnings multiple of just 12.4 and a dividend yield north of 4%.

Despite policy makers’ efforts to pump up the construction and manufacturing sectors, I see little evidence to suggest these sectors are about to boom. I wouldn’t be looking to gain exposure to these sectors through the stock market. The only caveat to that statement is that I think the Bank of England is very keen to ensure that the construction sector doesn’t lose the small foothold that it currently has on growth — so diversified companies (exposed to the construction sector) like Kier Group are worth looking into. In fact, Kier Group recently announced it was on track to meet its target of double-digit earnings growth.

The export sector has also been targeted by economists as ‘needy’. George Osborne says he wants to double UK exports to £1 trillion by 2020. Investors should be looking for well-established companies with an exposure to markets in China and Brazil. I’m inclined to stay away from companies with any significant exposure to the eurozone.

I must also add that exposure to the pharmaceutical sector (which takes care of both the services sector and the export sector) could also pay dividends next year. Despite their recent trouble, I favour GlaxoSmithKline. As I’ve said before GlaxoSmithKline’s research and development budget is huge — we’re talking billions of dollars’ worth. That’s how I believe this drugs giant well get back on its feet.

A broad exposure to the FTSE 100 over the past 12 months would have provided a bumpy ride. However, the index itself currently trades on a price to earnings (P/E) ratio of around 15.4, so it’s not considered too pricey just yet, and the average yield is around 3-4%. So unless you find the sweet spots, it can get a little boring and frustrating — especially considering how much risk you take on by being in the equity market in the first place.

This Fool has decided to stick with well-diversified stocks that are leveraged to the growing areas of the economy, and those sectors of the economy that have been targeted by policy makers as needing support.

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David Taylor has no position in any shares mentioned. The Motley Fool UK has recommended shares in GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.