Sector selection significantly defines portfolio performance. Stocks within a sector tend to move together, as companies within the same industry group are affected in similar ways by market and economic conditions. The prospects of a particular sector determine how all stocks within that sector are likely to perform. Determining which sectors are cooling down and which ones are coming into favour plays a very important role in the stock selection process. No matter what the market is doing, there will always be some sectors moving up and others heading down. Once a sector trend is identified, investors begin to favour it, first accumulating shares in the best companies of that sector. As more money flows into these stocks, the best companies become fully valued and money moves into second-rung stocks. Eventually, the sector, as a whole, becomes overpriced or economic conditions for it turn unfavourable and money moves to the next hot sector.

From software to steel and from sugar to construction and real estate, investors have been rotating their sectoral preferences in the Indian market. So, which are the sectors to look out for in 2007? Here are details of what we think will be the top eight sectors of the next year.

Cement:
Construction is hot and infrastructure is spreading. One sector that is deriving benefit from this is cement. Demand for cement has been rising consistently, thanks to a higher demand from construction and infrastructure, creating a small supply gap. This has resulted in rising product prices, higher realisations and better bottom-lines. Additional demand for cement is likely to arise when the Special Economic Zones and National Housing Board’s project of low-cost housing start getting implemented. Though cement manufacturing capacity is likely to go up by 70 MT, eventually creating an oversupply, it is likely to come on stream only after the second half of FY08. This means that the performance of cement companies will stay buoyant for the next one year or so. For now, the sector, as a whole, reported an average growth of 30% in its operational income while its operating profit grew at an average of 91% during the past five quarters. The sector operates at an average margin of 23% while its market-cap rose by a solid 95% during the past one year.

Engineering, Electronics & Electricals:
India’s manufacturing strength is reflected in this cluster of sectors that we bracket together. The booming domestic growth and export opportunities have made this sector fly in the past three years with revenues rising by 34% per year on an average and operating profit going up by 52%. Its market-cap went up by 56% over the last year mainly due to growth in the market-cap of engineering companies like Crompton Greaves and BHEL.

Telecom Services:
It is the most dynamic business today, enjoying a significant growth the world over. Telecom services in India have simply exploded beyond imagination in a very short span of time. The Indian market, with a population in excess of a billion, has more than 150 million telecom subscribers; 75 million were added only in the last two years! Telecom players have been adding around five million subscribers every month since December 2005, mainly due to the ease of using a mobile phone and the marketing efforts of cell phone companies. Even after such a scorching pace of growth, the Indian market for telecom services looks largely under-penetrated with a tele-density of just around 12%. Sri Lanka (16.64%), Pakistan (17.84%) and Maldives (35.7%) enjoy a higher penetration. This clearly spells out the opportunity for companies in the telecom services sector. The additional spectrum of 45 MHz to be opened for mobile services at the beginning of 2007 is likely to spur growth in this segment in a bigger way; even international players are now eyeing this opportunity for growth. The volume growth in handsets is so huge that Nokia, LG and Ericsson have planned to set up manufacturing facilities in India. The sector is likely to attract a total of $2 billion in FDI by 2007. The Indian market is likely to add another 100 million subscribers in the next year increasing the tele-density to 22% by the end of 2007.
Companies in this sector have recorded a very strong performance in the past five quarters (MoneyLIFE tracks five companies from this sector) with operating income rising by an average of 100% while operating profits jumped by a humungous 174%. The sector enjoys a margin of 29% at the operational level. The market cap of the sector was up by a whopping 145%.

Hotels:
If 2006 was a dream year for the hotel industry, 2007 promises to be even better. Higher room rates and a near-full occupancy level throughout the year backed by an ever rising number of business and leisure travellers put hotels in India in the big league globally. The World Travel and Tourism Council (WTTC) has ranked India as the fastest growing tourism destination of the world with a projected demand for over 100,000 new rooms, giving the hotel industry a new growth thrust in 2006. Companies in this sector have performed exceptionally well during the last couple of years with additional facilities being planned by almost all major players. Estimates put the number of branded hotel rooms in planning and developmental stage at close to 50,000, expected to be completed by 2010. Hotel companies have joined hands with realty companies with huge land banks to tide over the problem of higher land prices. The gap between higher demand and lower supply will not diminish very quickly, offering a clear visibility to the earnings potential of hotel companies. For now, the sector, as a whole, saw its operational income rise by an average of 27% during the past five quarters while its operating profit was up 49%. Hotels have operated at an average margin of 32% which is better even than software companies. Its market-cap was up 45% over the past one year.

Media & Lifestyle & Leisure:
The 2005 annual edition of the FICCI-PWC report on the Indian entertainment and media industry (E&M), released in March 2006, pegs the sector growth at 19%; it is expected to touch Rs83,740 crore by 2010 from Rs35,300 crore in 2004. Two sectors that are likely to benefit from this scenario the most are media and lifestyle & leisure. Companies from both these sectors are well-placed to take advantage of the rapidly growing economy, rising income levels and changing demography, which the report states are the key drivers of growth for the E&M sector as a whole. But two of the most important factors that are likely to fuel growth in this sector are lower media penetration and ad-spend.
Take, for instance, the print media with a current size of Rs10,900 crore. This sub-segment is estimated to grow at a CAGR of 12% to touch a size of Rs19,500 crore by 2010. Improving economic fundamentals, rising literacy rates and increasing urbanisation are fuelling the demand for newspapers and magazines. This has seen the emergence of many new players, as also the spread of existing ones. The television industry too has seen exponential growth, especially since the advent of cable TV. This segment is pegged to grow at a CAGR of 24% to touch Rs42,700 crore from a size of Rs14,800 crore. New distribution platforms like DTH and IPTV are likely to boost the growth further. Technology and corporatisation are changing a sub-segment of the entertainment industry -- filmed entertainment. The proliferation of multiplexes is one powerful example. From Rs6,800 crore, this sector is estimated to grow at a CAGR of 18% to touch Rs15,300 crore by 2010. The media sector reported an average growth of 62% in its revenues over the past five quarters, while its operating profit grew at 67% during the same period, at an average margin of 19%. The market-cap of the sector was up 150% in 2006. The lifestyle & leisure sector, on the other hand, reported an average rise of 34% in revenue and 67% rise in operating profit functioning at an average margin of 11%. Its market-cap was up 63% during the last one year.

Software:
There is nothing more to say about this sector which has been an evergreen performer and will continue to do well in 2007. India has built a position of strength in software services, thanks to the labour cost arbitrage it enjoys. This is reflected in the operational income growth, up by an average of 43% over the past five quarters and operating profit growth which rose by an average of 42%. The software sector operates at an average margin of 26%. The market-cap of software sector expanded by 36% last year.

Financial Services:
A benign interest rate regime, higher economic growth and a huge flow of foreign funds have rejuvenated the financial services sector in the last three years. Companies in this sector are likely to continue doing well in the next year, given that interest rates are not in a hurry to rise and the great Indian growth story, which is pulling international money to the Indian markets, will remain in place. The sector’s operating income grew at an average 39% over the past five quarters while its operating profit was up 37%. It operates at a high margin of 35%. The market-cap of the sector was up 35% over the last one year.