Three income-producing sectors that still look cheap

Many stock markets have been on an impressive run during the past year, with all major indices outstripping their historical average annual returns. The S&P 500 and the Nasdaq have delivered especially strong numbers.

This has been good news for global equity investors, who will be hoping the momentum persists in 2025. The flip side is that such spectacular levels of growth inevitably stoke fears that valuations may be getting out of hand.

In our opinion, whether these fears are justified very much depends on where you look. There are particular sectors and stocks that are expensive right now, but others remain underestimated by the wider investment community.

On the whole, for investors who are prepared to dig deeper in the search for attractive opportunities, the world can still be thought of as quite cheap. Here are three arenas where we continue to see real value.

Banks

The regulatory headwinds that followed the Global Financial Crisis made the banking sector seem like an unpromising target for investment. Fast-forward 15 years, though, and we find some banks have outperformed tech titan Microsoft in 2024.

How has this happened? The reality is that banks have become so well regulated in the wake of the Global Financial Crisis – and, as a consequence, so averse to lending – that they have effectively ended up flush with capital.

Banks have become so well regulated in the wake of the Global Financial Crisis – and, as a consequence, so averse to lending – that they have effectively ended up flush with capital.

This has enabled them to pay dividends and buy back their own shares in substantial quantities. As a result, the sector is now considerably safer and cheaper than many investors imagine.

By way of illustration, one of our own largest holdings, HSBC, currently offers a healthy dividend yield of about 6.5%. Despite this, it is still trading at well below its book value¹.

Energy

Capital expenditure is a major theme within our fund. The energy transition is a significant component of this allocation.

More investors are taking note of this sector amid the ongoing shift towards cleaner, sustainable energy sources. Yet it is interesting to reflect on areas where investment to date may have been insufficient.

Copper cable is a classic example. The electrification of society is going to require lots of it, but many of the businesses involved in its production have still to register on most investors’ radars.

Take Prysmian, which is based in Italy. Its share price has risen by well over 200%² during the past five years and we believe the company is poised to benefit further from growing demand as the energy transition gathers pace.

Defence

The capital expenditure theme extends to defence. This is a sector that has become more relevant in light of rising geopolitical tensions, not least with the tragedy in Ukraine reminding Europe that war is on its doorstep.

It could be argued that defence stocks may tumble if the conflicts that have dominated international headlines in recent years were somehow to end. President-elect Donald Trump has promised to cease hostilities between Ukraine and Russia “in one day”, for instance.

In our view, though, the sector’s newfound relevance is for the long term. Nations are conspicuously rebuilding their defence inventories, as underlined by a pledge in the autumn Budget to increase related spending in the UK.

The share price of one of our top holdings, BAE Systems, has gone up by around 125% during the past five years³. We feel that even now the company remains undervalued, belying its status as the biggest defence contractor in Europe and the seventh-largest in the world⁴.