This is a common occurrence. You heard people say that 'the real estate sector is hot' or 'the internet sector is growing rapidly' or 'let's buy the oil sector now. Energy price will rise again' next year. Sounds familiar? It is. This is because these people encouraged you to invest in specific sectors. What is wrong with sector investing? There is a common believe that rising tide will lift all boats. Therefore, when internet search is hot, then every companies in the field from Google to Looksmart will rise two to three folds, right? Wait a minute. Have you looked at the graph of Looksmart lately? If you haven't, here is the two year graph of Looksmart Ltd. Let me show you another example. Everybody knows about the rising energy price, most notably oil. Therefore, if you look at the five year chart of energy companies from Chevron and the like, you would expect similar upward trajectory movement, right? Wrong. Take a look at a five year chart of an energy company IvanHoe Energy Inc. here. So, should we look at sectors when investing? Absolutely. Sector search is very useful during your preliminary research. Auto sector is down. This might be a good place to find stock bargains, right? Yes. Should we blindly invest in any stocks in the auto industry? The answer is no. This goes back to the purpose of an investor. Investor exists to make the greatest return of assets possible while minimizing risk. The sensible way to do that is to compare investment alternative and pick the investment vehicles that may give investors the highest return. In the case of stock, we are looking at the expected profit of a company with respect to its stock price. This is the basis of the return on investment of stock investors. Therefore, once you identify that the auto sector is a bargain, your homework continues. You should find companies that can give you higher return than the risk free ten year treasury bond. Currently, the ten year is yielding 4.52%. Since 4.52% is risk free, we need to find stocks that can yield more than 4.52% for the foreseeable future. Yield on a common stock can be calculated by dividing earning per share (EPS) with the stock price. If you invert this ratio, you will get the most commonly discussed ratio in the investment community, Price Earning (P/E) ratio. Sector search is very useful in identifying future investment prospect. However, do not just blindly invest in stocks in specific sector. In the long run, stock price is correlated with the amounts of profit it can produce. Stock price does not correlate to the performance of other peers in the industry. |
