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Understanding Sectors

Understanding Sectors

Wall Street has a lot of pithy sayings. One of them is: “Don’t fight the market.” (Well, okay, it’s not THAT pithy.) But what it means is: follow the trends and stay tuned-in to how the market is doing overall and which sectors of stocks are doing well when others are not.

Today we’re going to talk about sectors of stocks. It’s not very difficult, but it could change your investing world and skills for the better.

Basically, you have a universe of thousands of stocks (we’ve talked about this in the past), which represent various companies that are publicly traded on the stock exchanges. One means of grouping stocks so that you can deal with them more efficiently is into sectors, which are subsets of the market or of industries whose components share similar characteristics. Stocks are grouped into various sectors depending on the company’s business. These groupings are different depending on the organization doing the grouping.

Standard & Poor’s, for example, breaks down the market into eleven sectors. Two of their designated sectors, utilities and consumer staples, are usually referred to as defensive sectors, which means that if the market gets uncertain, you can usually trust stocks in these sectors to perform well and provide some stability and security.

The other nine sectors (as defined by Standard & Poor’s) are transportation, technology, healthcare, financial, energy, consumer cyclicals, basic materials, capital goods and communications services. Now, other sources of information about the stock market might have many more sectors than the 11 sectors as designated by Standard & Poor’s. Or in some instances, you can find sub-sectors of these major sectors we’ve already mentioned.

You could even do your own sector breakdown if you were so inclined. Feel free to do so. It would certainly be a good exercise in defining sections of the market — and that would be a good exercise for you to get a firmer grip on what the stock market is all about.

But you don’t have to do that. Just understanding others’ groupings of sectors will stand you in good stead for your own investing in the market.

Some of the sectors you will find are self-explanatory. You know, for example, what the energy sector is composed of: stocks of companies that have something to do with energy, utilities, electric power, etc. Others may be a bit confusing or mysterious: what, for example, is a company that specializes in capital goods? (The answer is: any goods used by a company or organization to produce other goods. Examples might be office buildings, machinery used to produce other goods, equipment that would also serve the same purpose.)

So, there’s a bit of homework involved in finding out what each sector you might be interested in is all about.

Now, the next thing you can do with sectors is a bit of a detective game: find out which sectors might do well in the coming year. In other to accomplish this, you will need to figure out what the economy might look like, what is happening in the political arena that year, what the social climate is like. (This should be fun; if it isn’t, just let another resource for research do sector discovery for you.)

Let’s say you think healthcare should do well because the Baby Boomers are aging and are going to need more medical attention and services. In a pre-election year, many healthcare companies might be positioning themselves so that if either party wins, they will survive and thrive. If you believe this, then you can begin to do the research that will provide you with two or three of the top companies within that sector.

If a sector is predicted to do badly in the near future, you might want to stay away from it. If the political climate of the world is such that oil exploration and drilling become volatile, you might not want to invest in oil and gas drilling companies or in that sector.

It does matter which sectors overall are predicted to do well and which are predicted to do poorly. A good company in a bad sector might find it very difficult to pull itself up and thrive in spite of being in a bad sector. Chances are that a company in a bad sector will do badly, reflecting the majority of the companies in that particular sector.

On the other hand, a good company in a sector that is possibly going to do well for whatever reasons you can ascertain is most likely going to go up in value.

So, understanding sectors is important. Knowing which ones you should be in and stay out of can make the difference between a successful stock portfolio and one that is merely mediocre.

We’ll talk some more about sectors next week. So be sure to come back!!