With So Many Options Where Does One Start

Last time I checked, the Nasdaq had more than 3200 companies listed. Following all of them is simply impossible. So what do most investors do ? Short-list a bunch of stocks they like and stick to them. How do you short-list which ones to invest from so many options ? Where do you start ? Frankly, there is no straight answer to that. The best thing would be to break these stocks into smaller groups and then decide how to proceed. Ok so lets break them into smaller groups. But wait…what criteria to use to break them into smaller groups. I found few of the important criterias that make the selection process much more easy.

Company Size
Break up based on company size. By company size, i mean their market capital. Market capital is nothing but the total dollar value of the company’s outstanding shares. Based on market capital a stock can be a large cap, mid cap or a small cap.

Large Cap = Market cap of anything more than $10 billion
Mid Cap = Market cap valued between $1 billion and $ 10 billion
Small Cap = Market cap of anything less than $1 billion

The larger the market cap, the more established the company, which means more stable stock prices. Small cap and mid cap companies usually have a higher potential for future growth than large cap companies, but their stock tends to fluctuate more. In short, volatility factor goes down as the market capital goes up. Large caps are less volatile as compared to small caps. For an aggressive portfolio trade in small/mid cap. For conservative portfolio trade in large cap. Exxon Mobil Corp XOM has the largest market cap at $427 billion.

Break up based on company business. 12 known sectors are basic materials, capital goods, conglomerates, consumer cyclical, consumer non-cyclical, energy, financial, health care, services, technology, transportation and utility. This definitely takes you one step closer to your potential candidates. Again you can break the sectors into subsectors to make it that much easier to find the right match. (For example, you can break a Technology sector into subsectors like Computer Networks, Computer Hardware, Semiconductors, Computer Software…etc etc). Which sector to invest in, basically depends on your overall understanding of the sector. Say you understand the Technology and Energy sector better than the others, and think that most tech & energy companies will perform better compared to others. That means you have potentially narrowed down your search. However always remember that each of these sectors go through boom and a bust (For example, technology sector saw a boom before the dotcom bubble burst, energy sector saw a boom in recent years with oil prices climbing to record highs), so never put all your eggs in the same basket (do not buy all tech sectors).

Cyclical Stocks
Break up based on business cycles. Certain companies are like rollercoasters. When the economy is good, the profits are up and the stock price rises. When the economy is bad, the profits are down and the stock price falls (For example, the auto industry makes a profit when the economy is doing good, since consumers have more money to spend on new cars. Another cyclical industry is the housing industry). Investing in cyclical stocks can possibly give good returns if you can correlate an industry (say auto-industry or tech industry) with the current economy.

Non-cyclical Stocks
Non-cyclical stocks are the opposite of cyclical stocks. If you think you do not have sufficient resources to find out possible correlations between the industry and the economy, stick to non-cyclical stocks. Non-cyclical stocks would be in industries such as healthcare, food and utilities where the demand for goods and services is constant, since people always need health, food and electricity, no matter how is the economy performing. Non-cyclical stocks tend to do well during economic downturn, but actually sag behind cyclical stocks when the economy is booming.

Dividend Stocks
Break up based on dividend returns. Dividend is a good diversification for the portfolio. Even though the stock prices fall, the high dividend can offset the loss. High dividend can assure a steady income.

Technical Analysis
Break up based on technical analysis. There are alot of analyst/traders who buy/sell/short stocks based only on technical analysis. Technical analysis helps one understand the direction of the stock. Stock movement is predicted based on past performance. Also future estimated growth of the company is used a factor to look for long term stocks. You can group stocks based on P/E ratio, EPS and PEG. P/E ratio should generally be low, indicating cheaper stock price compared to earnings. EPS should be as high as possible, indicating high earnings per share. PEG should be as low as possible, indicating higher future growth. Technical Analysis is an excellent tool to pick potential candidates.

Conclusion: With so many options in the stock market it can be difficult to decide where to invest. By breaking these stocks into smaller groups using certain criterias can make the decision process that much easier. Company size, Sector, Cyclical stocks, Non-cyclical stocks, Dividend stocks and Technical analysis are some of the important criterias to use to find potential match.

Recommendation: Using these criteria you can short-list potential candidates. Infact ideally you can combine all these criteria to come up with the perfect list that matches your style of investing. Once you have short-listed them, preferably stick to them. Trade in and out of them as per the economic conditions. I assure you, you will find success !! I am sure i missed out few more important criterias and would love to hear from the audience.

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(Source: Investorguide)