GROUP SELECTION
If the prognosis is for an expanding economy, then certain groups
are likely to benefit more than others. An investor can narrow the field to
those groups that are best suited to benefit from the current or future
economic environment. If most companies are expected to benefit from an
expansion, then risk in equities would be relatively low and an aggressive
growth-oriented strategy might be advisable. A growth strategy might involve
the purchase of technology, biotech, semiconductor and cyclical stocks. If the
economy is forecast to contract, an investor may opt for a more conservative
strategy and seek out stable income-oriented companies. A defensive strategy
might involve the purchase of consumer staples, utilities and energy-related
stocks.
To assess a industry group's potential, an investor would want to
consider the overall growth rate, market size, and importance to the economy.
While the individual company is still important, its industry group is likely
to exert just as much, or more, influence on the stock price. When stocks move,
they usually move as groups; there are very few lone guns out there. Many times
it is more important to be in the right industry than in the right stock! The
chart below shows that relative performance of 5 sectors over a 7-month time
frame. As the chart illustrates, being in the right sector can make all the
difference.
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NARROW WITHIN THE
GROUP
Once the industry group is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis. Investors are usually interested in finding the leaders and the innovators within a group. The first task is to identify the current business and competitive environment within a group as well as the future trends.
How do the companies rank according to market share, product position and competitive advantage?
Who is the current leader and how will changes within the sector affect the current balance of power ?
What are the barriers to entry ?
Success depends on an edge, be it marketing, technology, market share or innovation. A comparative analysis of the competition within a sector will help identify those companies with an edge, and those most likely to keep it.
SELECTING THE SECTOR :-
STOCK MARKET SECTORS
A sector refers to a group of stocks representing companies in a similar line of business or industry. All of the stocks on the S&P TSX can be broken down into 10 different categories (sectors) based on their line of business or industry.
As you can see from the pie chart below, the Financial and Energy sectors dominate the Canadian landscape, with more than 50% of the TSX comprised of companies in these sectors. The Materials sector is also quite large and these three sectors alone comprise over 75% of the companies on the TSX. Meanwhile, the small weightings of health care, utilities and consumer staples provide investors with very little domestic exposure to these important sectors.
SECTOR ROTATION
Sector rotation is an investment strategy that consists of moving money from one industry sector to another in an attempt to beat the market. At different stages in an economy, an investor or portfolio manager may choose to shift investment assets from one investment sector to another, based on the current business cycle(since different sectors are stronger at different points in the business cycle).
DEFENSIVE
Defensive stocks include utilities and consumer staples. These companies usually don’t suffer as much in a market downturn because people don’t stop using energy or eating. They provide a balance to portfolios and offer protection in a falling market.
However, for all their safety, defensive stocks usually fail to climb with a rising market for the opposite reasons they provide protection in a falling market: people don’t use significantly more energy or eat more food.
Defensive stocks do exactly what their name implies, assuming they are well run companies. They give you a cushion for a soft landing in a falling market.
More Information on the Intelligent Investor
You can find more information and a book review of the Intelligent Investor in the top picks section.
HOW TO USE
This is extremely helpful, since one of the ways to use sector information is to compare how your stock or a stock you may want to buy, is doing relative to other companies in the same sector.
If all the other stocks are up 11% and your stock is down 8%, you need to find out why. Likewise, if the numbers are reversed, you need to know why your stock is doing so much better than others in the same sector – maybe its business model has changed and it shouldn’t be in that sector any longer.
ATTRACTIVE STOCK
1 HCL Infosystems Ltd. IT – Hardware
2 PSL Ltd. Steel & Iron Products
3 SRF Ltd. Textile – Manmade Fibres
4 Andhra Bank – Public
5 Corporation Bank - Public
6 Aarti Industries Ltd. - Chemicals
7 Allahabad Bank – Public
8 Balmer Lawrie & Company Ltd - Diversified
9 Graphite India Ltd. - Electrodes & Welding Equipment
10 Indian Bank – Public
11 Deepak Fertilisers & Petrochemicals Corpn. Ltd - Fertilizers
12 Syndicate Bank – Public
13Jammu
14 Bajaj Holdings & Investment Ltd Finance – Investment
that have superior management and consistently throw off earnings quarter after quarter. But that is only half the work needed to find a good investment.
CONCLUSION
When you have a sense of where the economy and stock market are headed, you can use that information to begin considering those industrial sectors in the best position for growth.
Once you have identified one or more industrial sectors, you can use stock screening tools to help you narrow the search down to individual companies.
If you already own individual stocks (or stock mutual funds), use industrial sectors to make sure you are not over-invested in any one sector. Diversification will help you better weather ups and downs.
SELECTING THE SECTOR :-
STOCK MARKET SECTORS
A sector refers to a group of stocks representing companies in a similar line of business or industry. All of the stocks on the S&P TSX can be broken down into 10 different categories (sectors) based on their line of business or industry.
As you can see from the pie chart below, the Financial and Energy sectors dominate the Canadian landscape, with more than 50% of the TSX comprised of companies in these sectors. The Materials sector is also quite large and these three sectors alone comprise over 75% of the companies on the TSX. Meanwhile, the small weightings of health care, utilities and consumer staples provide investors with very little domestic exposure to these important sectors.
SECTOR ROTATION
Sector rotation is an investment strategy that consists of moving money from one industry sector to another in an attempt to beat the market. At different stages in an economy, an investor or portfolio manager may choose to shift investment assets from one investment sector to another, based on the current business cycle(since different sectors are stronger at different points in the business cycle).
CYCLICAL STOCKS
Cyclical stocks, on the other hand, cover everything else and tend to react to a variety of market conditions that can send them up or down, however when one sector is going up another may be going down.
Here is a list of the nine sectors considered cyclical:
· Basic Materials
· Capital Goods
· Communications
· Consumer Cyclical
· Energy
· Financial
· Health Care
· Technology
· Transportation
Most of these sectors are self-explanatory. They all involve businesses you can readily identify. Investors call them cyclical because they tend to move up and down in relation to businesses cycles or other influences.
Basic materials, for example, include those items used in making other goods – lumber, for instance. When the housing market is active, the stock of lumber companies will tend to rise. However, high interest rates might put a damper on home building and reduce the demand for lumber.
Cyclical stocks, on the other hand, cover everything else and tend to react to a variety of market conditions that can send them up or down, however when one sector is going up another may be going down.
Here is a list of the nine sectors considered cyclical:
· Basic Materials
· Capital Goods
· Communications
· Consumer Cyclical
· Energy
· Financial
· Health Care
· Technology
· Transportation
Most of these sectors are self-explanatory. They all involve businesses you can readily identify. Investors call them cyclical because they tend to move up and down in relation to businesses cycles or other influences.
Basic materials, for example, include those items used in making other goods – lumber, for instance. When the housing market is active, the stock of lumber companies will tend to rise. However, high interest rates might put a damper on home building and reduce the demand for lumber.
DEFENSIVE
Defensive stocks include utilities and consumer staples. These companies usually don’t suffer as much in a market downturn because people don’t stop using energy or eating. They provide a balance to portfolios and offer protection in a falling market.
However, for all their safety, defensive stocks usually fail to climb with a rising market for the opposite reasons they provide protection in a falling market: people don’t use significantly more energy or eat more food.
Defensive stocks do exactly what their name implies, assuming they are well run companies. They give you a cushion for a soft landing in a falling market.
SEVEN
TESTS OF DEFENSIVE STOCK SELECTION --- KEYS TO
PUTTING TOGETHER A CONSERVATIVE PORTFOLIO OF COMMON STOCKS
Each autumn, I read Benjamin Graham's Intelligent Investor.
It's principles are timeless, unquestionably accurate, and contain a sound
intellectual framework for investing that has been tested by decades of
experience. As I considered the content of my weekly article, I decided
to focus on the seven tests prescribed by Graham in Chapter 14, Stock Selection for the Defensive
Investor. Each of these will serve as a filter to weed out the
speculative [or 'risky'] stocks from a conservative portfolio.
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1. Adequate Size of the
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In the world of investing, there is some safety
attributable to the size of an enterprise. A smaller company is generally
subject to wider fluctuations in earnings. Graham recommended [in 1970] that
an industrial company should have at least $100 million of annual sales, and
a public utility company should have no less than $50 million in total assets.
Adjusted for inflation, the numbers would work out to approximately $465
million and $232 million respectively.
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2. A Sufficiently Strong Financial Condition
|
According to Graham, a stock should have a current ratio of at least two. Long-term debt should not exceed working capital. For public utilities the debt should not exceed
twice the stock equity at book value. This should act as a strong buffer against the
possibility of bankruptcy or default.
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3. Earnings Stability
|
The company should not have reported a loss
over the past ten years. Companies that can maintain at least some level of
earnings are, on the whole, more stable.
|
4. Dividend Record
|
The company should have a history of paying
dividends on its common stock for at least the past twenty years. This should
provide some assurance that future dividends are likely to be paid. For more
information on the dividend policy, read Determining Dividend Payout: When Should
Companies Pay Dividends?.
|
5. Earnings Growth
|
To help ensure a company's profits keep pace
with inflation, net income should have increased by one-third or greater on a
per-share basis over course of the past ten years using three-year averages
at the beginning and end.
|
6. Moderate Price to Earnings Ratio
|
For inclusion into a conservative portfolio,
the current price of a stock should not exceed fifteen times its average
earnings for the past three years. This acts as a safeguard against
overpaying for a security.
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7. Moderate Ratio of Price to Assets
|
Quoting Graham, "Current
price should not be more than 1 1/2 times the book value last reported.
However, a multiplier of earnings below 15 could justify a correspondingly
higher multiplier of assets. As a rule of thumb we suggest that the product
of the multiplier times the ratio of price to book value should not exceed
22.5 (this figure corresponds to 15 times earnings and 1 1/2 times book
value. It would admit an issue selling at only 9 times earnings and 2.5 times
asset value, etc.)"
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More Information on the Intelligent Investor
You can find more information and a book review of the Intelligent Investor in the top picks section.
HOW TO USE
Stocks sectors are helpful sorting and comparison tools.
Don’t get hung up on using just one organization’s set of sectors, though.MorningStar.com uses slightly different sectors in its tools, which
let you compare stocks within a sector.
This is extremely helpful, since one of the ways to use sector information is to compare how your stock or a stock you may want to buy, is doing relative to other companies in the same sector.
If all the other stocks are up 11% and your stock is down 8%, you need to find out why. Likewise, if the numbers are reversed, you need to know why your stock is doing so much better than others in the same sector – maybe its business model has changed and it shouldn’t be in that sector any longer.
ATTRACTIVE STOCK
Naturally, investors
want aboard this gravy train. To find a seat, they are willing to pay a
premium. There is nothing wrong with wanting a piece of
this type of company.
The problem comes when you are a late arrival
and the price of admission (stock price) has climbed too high.
How high is too high? That’s a question that every investor must asked
and answer.
Too often, investors jump when they should stand
back and take a hard look. Investors who have a chance for success look for
good companies, companies like
1 HCL Infosystems Ltd. IT – Hardware
2 PSL Ltd. Steel & Iron Products
3 SRF Ltd. Textile – Manmade Fibres
4 Andhra Bank – Public
5 Corporation Bank - Public
6 Aarti Industries Ltd. - Chemicals
7 Allahabad Bank – Public
8 Balmer Lawrie & Company Ltd - Diversified
9 Graphite India Ltd. - Electrodes & Welding Equipment
10 Indian Bank – Public
11 Deepak Fertilisers & Petrochemicals Corpn. Ltd - Fertilizers
12 Syndicate Bank – Public
13
14 Bajaj Holdings & Investment Ltd Finance – Investment
that have superior management and consistently throw off earnings quarter after quarter. But that is only half the work needed to find a good investment.
CONCLUSION
You never want to be making investment decisions in a vacuum.
Using sector information, you can see how a stock is doing relative to its
peers and that will help you understand whether you have a potential winner or
loser.
As you begin your search for investment
candidates, you should consider which industrial sectors offer the best
prospects for growth (or value) investments.
Industrial sectors are groupings of similar types of
companies. These groupings are important because they give stock investors an
idea of how well (or poorly) individual companies are performing relative to
their industrial peers.
When you have a sense of where the economy and stock market are headed, you can use that information to begin considering those industrial sectors in the best position for growth.
By comparing the relative performance of the
various industrial sectors you can gain some insight about where to begin
looking for investment candidates. You can also use sector performance
information to measure an individual company's numbers.
Once you have identified one or more industrial sectors, you can use stock screening tools to help you narrow the search down to individual companies.
If you already own individual stocks (or stock mutual funds), use industrial sectors to make sure you are not over-invested in any one sector. Diversification will help you better weather ups and downs.
Here are three initial steps to better stock
investing:
·
Identifying industrial sectors with prospects for growth 
Thanks for the very detailed guide!
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