UK: Sector classification can be a bitter pill for some.

UK: Sector classification can be a bitter pill for some. - Does it matter what company a company keeps on the Stock Exchange? Investors rate the various sectors of the stock market in very different ways. In the healthcare and pharmaceuticals sector, for

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Last Updated: 31 Aug 2010

Does it matter what company a company keeps on the Stock Exchange? Investors rate the various sectors of the stock market in very different ways. In the healthcare and pharmaceuticals sector, for example, companies' shares are priced at around 30 times earnings.

At the other extreme, diversified industrials, currently the doghouse of the stock market, they are rated at only eight times earnings.

Guy Fisher, a quantitative analyst with NatWest Markets in Edinburgh, believes that companies generally like their earnings performance to be compared with that of their peer group. Many believe that they have been placed in the wrong sector, however, and this has depressed their share rating. 'But, from an investor's point of view, I don't think that it is a major issue,' he says.

The FTSE-100 International Committee meets once a year to consider major changes in sector classifications, it also holds quarterly meetings to tidy up changes brought about by takeovers or significant changes in a company's business. The Committee usually places companies in the sector in which they earn most of their profits. 'We consider 10 or 12 cases every quarter and usually relocate up to eight,' says Stephen Vale of FTSE-100 International. Half of these are brought at the initiative of the companies themselves and if it is marginal normally go with the company's preference.

In December, the Committee said that it would be introducing a separate classification for information technology (IT) companies. Some investors bought IT shares quite heavily on hearing the news, expecting that a separate identity would lead to a further re-rating of an already highly rated group of companies. The prospective p/e ratios of Sema, Logica, Misys, Parity and Sage are anything between the mid-20s to mid-40s, compared with an average for the stock market of 17 to 18.

Changing sectors can provide a shot in the arm to companies but only if the company turns itself round. Take the likes of the Hanson, BTR and Williams conglomerates, highly rated in the '80s but drastically downsized since then. Hanson split itself up and BTR is taking a hefty axe to its business portfolio.

But, while Williams recently escaped from the now unpopular diversified industrials sector to support services by boiling down its portfolio to security and fire protection, it has failed to achieve an instant re-rating simply by changing sector.

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