Sector Screener: an underperforming sector to buy for long term

An intensifying global trade war is likely to dissuade many investors from buying shares. After all, protectionist policies put in place by major economies including the US and China are likely to have a negative impact on global GDP growth prospects in the short run. And with the potential for further tariffs, the outlook for economic activity could realistically worsen before it improves.

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Inevitably, companies that are dependent on the economy’s performance are likely to be among the hardest hit by tariffs. This could be a key reason why the FTSE 350 Support Services sector has slumped by over 11% in the past month. This compares with a more modest 3% decline for the wider FTSE 350 index, with the apparent cyclicality of many of the sector’s members likely to have weighed on their recent share price performance.

However, their prospects could prove to be more upbeat than many investors realise. While the sector’s performance is undoubtedly affected by the economy’s growth rate, several of its incumbents have excellent long-term track records of earnings growth despite experiencing significant economic undulations along the way. Indeed, in some cases they have produced mid-to-high single-digit annualised profit growth over the past 10 to 15 years. Therefore, even if their financial performance comes under pressure in the near term, they have the potential to generate excellent returns over the long run.

Source ShareScope. Data as at 14 March 2025. Past performance is not a guide to future performance.

Source ShareScope. Data as at 14 March 2025. Past performance is not a guide to future performance.

Potential catalysts

Of course, the Support Services sector contains a wide range of companies that operate across a diverse range of market segments. Indeed, its members range from building supplies companies to pest control firms, and from recruitment companies to businesses that specialise in providing financial data and analytics. Therefore, it is difficult for investors to accurately forecast how the sector will perform given the broad range of catalysts that could have differing impacts on each of its subsectors.

However, monetary policy easing across developed markets is likely to have a positive impact on the overall sector’s medium-to-long-term prospects. Already, several interest rate cuts have been enacted in the US, UK and the eurozone. However, due to the existence of time lags, they have not yet had their full impact on the economy’s performance. When combined with the prospect of further monetary policy easing, they could act as a catalyst for several firms in the Industrial Support Services sector given their relatively cyclical status.

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Indeed, the International Monetary Fund (IMF) currently forecasts that several developed economies will deliver attractive rates of GDP growth over the coming years. For example, eurozone GDP growth is expected to remain at 1% this year before increasing to 1.4% next year, while the UK’s economy is due to expand by 1.6% this year and 1.5% next year, versus 0.9% last year. The US economy’s growth rate, meanwhile, is forecast to remain above 2% in both 2025 and 2026.

Clearly, those figures could come under pressure in the short run due to the impact of tariffs. Investors, though, appear to have at least partly factored in the prospect of greater economic uncertainty. The disappointing performance of the Industrial Support Services sector over recent weeks means that several of its incumbents now trade at more attractive levels. This could not only equate to greater capital growth potential over the long run, but may also help to support their share prices in the short run.

Risk considerations

Of course, investors in the Industrial Support Services sector should take a long-term view. The inherent cyclicality of many of the sector’s members means that short-term volatility in both their financial and share price performance could be relatively high.

Furthermore, selecting companies that have solid financial positions could reduce overall risk. They may be better placed to overcome further economic uncertainty. Similarly, firms that have a clear competitive advantage may be in a superior position to not only deliver a solid financial performance in the short run, but also to capitalise on an improving economic outlook over the long run.

Source ShareScope. Data as at 14 March 2025. Past performance is not a guide to future performance.

Intertek

Industrial Support Services sector member Intertek Group (LSE:ITRK) has recorded a share price fall of 6% over the past month. This is despite a positive reaction to the FTSE 100 firm’s annual results, with the testing and inspection company, which ensures that products from a wide range of industries meet required standards, reporting an improved financial performance versus the previous year.

The firm’s like-for-like sales growth amounted to 6.3%, while a 100-basis point increase in its operating profit margin to 17.4% contributed to a 15% rise in earnings per share (EPS). This means that the company’s bottom line has now increased at an annualised rate of 6.2% over the past decade despite it experiencing several major economic challenges along the way.

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Over the medium term, the business expects to further increase its operating profit margin to 18.5% through a mixture of efficiency gains and a focus on higher margin growth opportunities. Its solid financial position, as evidenced by a net gearing ratio of 55% and net interest cover of around 14, suggests it has the means to conduct further M&A activity over the coming years.

A strong balance sheet, meanwhile, meant the company was able to announce a £350 million share buyback programme alongside its annual results. It also completed a planned rise in its dividend payout ratio from 50% in 2023 to 65% in 2024. As a result, dividends per share for the full year rose by just over 40%, and the stock now has a prospective dividend yield of 3.5%.

Of course, the company’s shares could come under pressure in the short run given the world economy’s uncertain outlook. And with them trading on a price/earnings (PE) ratio of 18.7, there are clearly cheaper options available elsewhere in the FTSE 350 index.

However, with a solid financial position, an excellent long-term track record of earnings growth and scope for further profit margin improvement, the company’s risk/reward opportunity appears to be attractive on a long-term view.

Diploma

Fellow Support Services sector member Diploma (LSE:DPLM) also seems to offer an upbeat long-term outlook. The FTSE 100 distribution company, which provides a wide range of specialist products to firms across a variety of industries, recently released an encouraging first-quarter trading update. It showed that revenue rose by 12% year-on-year, with organic revenue growth amounting to 7%.

The company expects to deliver an 8% rise in total sales for the full year, as well as a slight increase to last year’s operating profit margin of 20.9%, despite the presence of an increasingly uncertain economic environment. And with it having generated an annualised increase in EPS of 16% over the past 15 years, the company has a strong track record of above-average profit growth.

Encouragingly, the firm has a solid balance sheet through which to ride out potential economic woes and make further acquisitions. Its net debt-to-equity ratio, for example, is 56%, while net interest payments were covered over 10 times by operating profits during its latest financial year.

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Even after falling by 11% in the past month, thereby trading in line with the wider Industrial Support Services sector, Diploma still trades on a forward PE ratio of 24.2. This is undoubtedly rich relative to the wider FTSE 100 index – even while the large-cap index trades within 4% of its all-time high.

However, the company’s excellent track record of earnings growth, sound fundamentals and the prospect of improving operating conditions as interest rate cuts bolster the world economy’s outlook, mean that it could generate relatively attractive capital gains over the long run.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.