In this article, we’ll see an approach to identify the best sectors to invest in the Indian stock market. The good sectors are the ones that are intrinsically profitable. So, this analysis is totally based on the concept of profitability. The best sectors will be the ones that are most profitable.
In this article, we’ll not talk about specific stocks. The focus will be on sectors and industries only.
What is the objective of this article? To know which are the best sectors to invest in the Indian stock market for a long-term horizon. Once a sector is identified, finding good stocks within that sector will be the goal. How do I identify good stocks? I use my stock analysis worksheet to do a deeper fundamental analysis.
Indian Stock Market Viewed As Sectors & Industries
The Indian stock market is divided into the above 17 sectors. All companies that trade in the market will fall in either of these sectors. For example, RIL comes under the energy sector and TCS is in the technology sector.
But keeping our analysis at the sector levels will not be effective. Why? Because the market has matured, and within each sector, multiple industries have developed. So we will do the profitability analysis at the industry level. I think, industry analysis will yield the desired objective.
Breaking down the sectors further, it yielded 184 number industries. You can check this link to get a list of sectors and the industries within it.
Now we will do the profitability analysis to rate all 184 number industries. Idea is to identify the best sectors to invest in.
How The Analysis Is Done?
I’ll use our stock screener’s database for the analysis. Using this database, I’ll calculate the profitability of each industry within a sector. It will be done using the profitability ratios of the constituent stocks. Following ratios will be used to quantify the profitability of each industry:
- ROA (Return on Asset)- 5Yr Avg.
- ROE (Return on Equity) – 5Yr Avg.
- ROCE (Return on Capital Employed) – 5Yr Avg.
- OPM (Operating Profit Margin) – 5Yr Avg.
- NPM (Net Profit Margin) – 5Yr Avg.
After the analysis is done each industry’s profitability will be quantified based on the above five (5) parameters. Each industry will also be quantified based on the average market cap (M.Cap) of its constituent stocks.
Once every industry is quantified based on its market capitalization and profitability ratios, I’ll use an algorithm to score all the industries. The scoring is done on a comparative basis. Once the scoring is done, the industries will be ranked. The most profitable, best sector/industry, will earn a rank one and so on.
Once the ranking of all industries is done, the final report will look like this.
Limitations of The Method
An industry that is plagued with too many low-performing stocks will get a lower rank. In a way it is good, but we might also miss out on few potential companies. How?
Let’s take the example of a sector/industry that is Technology/Software. In this industry, there are about 170+ number companies. Some of the top companies of this genre are TCS, Infosys, Wipro, etc. About 25 to 30 number companies in this industry have a history of displaying above-average profitability.
But as we go down the list, the profitability numbers begin to fade away. Why does it happen? Because of the excessive competition within the industry. Too many players operating in one industry ultimately reduces the economic moat of the industry itself. It becomes difficult to maintain sales and margins in such an industry.
So, a low ranking given to the software industry is understandable. But it does not mean that there will be no good stocks in it.
It is possible to use an algorithm that will limit the disadvantage to the industry due to excessive competition. It will be good for industries like software, but I thought it is better to keep it this way. Why? Because being aware of a sector that is excessively crowded is also important.
A similar example is in the financial sector as well, except the asset management industry. Too many players have made this sector muddy. They all operate at comparatively lower margins. My algorithm highlights this fact by giving low ranks to most of the industries operating in the financial sector.
List of Best Sectors To Invest In India 
(Updated on 16-Sep-2022)
|2||Natural Gas Utilities||81729.32||13.02||24.57||27.84||24.38||13.85||2|
|3||Credit Ratings & Information||9464.14||12.31||22.36||30.02||44.05||27.08||3|
|6||Non-Metallic mineral prod.||625.39||16.07||23.93||28.40||23.99||14.56||6|
|7||Household & Personal Products||57920.54||9.62||11.43||24.53||16.94||7.74||7|
|10||Tractors & Farm Machinery||13797.27||10.10||14.76||20.35||15.33||9.11||10|
ROA: Return on Asset, ROE: Return on Equity, ROCE: Return on Capital Employed, OPM: Operating Profit Margin, NPM: Net Profit Margin
In the last couple of years, all sectors have faced setbacks due to the COVID-19 pandemic. This is the reason why I’ve taken the 5-Years average numbers to give a perspective. This way the negative effect of the last 2-years will be neutralized.
For me, sector analysis is important as it helps to focus on healthy sectors/industries. Why it is important? A company operating in an inherently low-profitable sector will not yield high margins. Similarly, a top-ranked sector/industry will have stocks that are fundamentally strong.
It is essential to highlight that this sector analysis is done based on past performances. In most cases, the sector is likely to continue the same in the future. But to get a better perspective of future performance, more study needs to be done.
For long-term investors, there is a great resource provided by Ibef on industry analysis. It covers almost all important sectors/industries of the Indian stock market. The data of the report is also summarized as infographics that make reading even easier.
I hope you liked this article. Have a happy investing.