Building a Stock Portfolio. The #1 Rule - Diversification When building a stock portfolio, you need to diversify. Diversification by sector This is

  • View
    214

  • Download
    0

Embed Size (px)

DESCRIPTION

Sectors A sector is: 1. An industry or market sharing common characteristics 2. An area of the economy in which businesses share the same or a related product or service.

Transcript

Building a Stock Portfolio The #1 Rule - Diversification When building a stock portfolio, you need to diversify. Diversification by sector This is where you do not own any two stocks that work in the same sector. It is suggested that you own at least 5 stocks so that you can diversify among different sectors. A companies sector can be responsible for over 20% of the stocks performance. Therefore you need to choose good sectors and be prepared for a change in a sectors performance. You must not put all your eggs in one basket in case that basket of stocks performs poorly. Sectors A sector is: 1. An industry or market sharing common characteristics 2. An area of the economy in which businesses share the same or a related product or service. Problem with Diversification by Sector In the past people bought sector ETFs (Electronic Traded Fund) mostly, therefore if a sector started to do bad, the whole sector would sell off and vice versa. Now days, people can by ETFs (Electronic Traded Fund) of types of stocks, like dividend payers, high growth, gold etc What this means is that if you had a high dividend paying telecommunications company and a high dividend paying bank, then they could both get hit when interest rates rise because people will sell the high dividend paying ETF. New Diversification In modern days, you need to not only diversify among sector, but also among types of companies. You need 5 things in any diversified portfolio and no more than 20% of your money in each : 1) Gold 2) Stock from a Healthy Geography 3) High dividend paying Stock 4) Growth Stock 5) Speculataive Stock Gold Gold is insurance and usually will go up when everything else is going down. Over the long term it is a great investment because of the low supply in the world. You can either buy gold shares IAU = i-shares Gold ETF or GLD = SPDR gold trust You DO NOT want to buy gold miners because it is a risky and dangerous business. They usually dont make money consistently. No more than 10% in a portfolio Dividend Stocks You want to look for companies with more than 3% dividend yield. Accidental High Yielders Companies who have inflated dividend yields because they have come down in price so much. (4%+ dividend yield) Yield Cushion Dividend paying stocks have a stable bottom, if the dividend is safe at usually around the 4% yield level. (Stock wont get below 4% yield level usually, so it is a safer investment) Examples : Secular Growth Stocks These companies are driven by powerful long-term stories that transcend the strength or weakness of the underlying economy. Meaning they will do well no matter what happens with the economy. look for big-picture themes, where you have a company that's a play on a much broader trend. Speculative Stocks Not only is it okay for you to own those tempting, risky, broken-seeming stocks that trade in the single digits, it's a necessity because they hold the biggest gains, but also can cause the most loss. It is recommended the overall goal for spec stock is to invest in tiny, largely unknown companies in sectors that could catch a turnaround. One way to identify these stocks is to look for companies that trade in the single digits. Also look for new upcoming companies that are tiny Biotechs are some of the most rewarding speculations because when they get approved for a new drug by the FDA to cure/treat something they can skyrocket. The key to speculation is that they tend to have a short lifespan. So, the trick is to lock in profits as soon as you have them and avoid getting burned. No More than 20% of your money in a speculative stock ever! Stock from a Healthy Geography The global market is very important to monitor. You need to identify what parts of the world are doing well and then buy a stock or stocks How to Select Stocks Start with an industry or a company that's familiar to you. Then look at the following pieces of information : 1) Consider price and valuation This is companies P/E ratio 2) Evaluate financial health 3) Check 52 Week High List and look for a 5-8% correction in a recent 52 week high performer 4) Look for companies that benefit from a large Trend 5) Know what type and sector you are look for to fill your portfolio and keep it diversified 6) Insider Buying 7) Price, look for a pullback from recent highs of about 3-8%. P/E ratio Known as price to earnings ratio The price/earnings ratio is a stocks last price divided by its latest annual earnings per share. It is expressed mathematically as: A good p/e ratio is about 15, more than this is considered to be expensive. But also depends on the growth rate, we pay more for high growing companies. (More to come) Example of P/E ratio calculations For example, if a companys latest yearly earnings per share is $1 and its most recent stock price is $20, the P/E ratio would be 20. P/E= Recent Price/earnings = 20/1 = 20 In the financial media one would hear that the stock is trading at 20 times earnings. PEG ratio The PEG ratio can help you determine if a stock's P/E has gotten too high in these cases by giving you an idea of how much investors are paying for a company's growth. A stock's PEG ratio is its forward P/E divided by its expected earnings growth over the next five years as predicted by a consensus of Wall Street estimates. PEG = (Forward P/E Ratio) / (5-Year EPS Growth Rate) the PEG ratio should be used with caution. PEG relies on two different Wall Street analyst estimates--next year's earnings and five-year earnings growth--and thus is doubly subject to the possibility of overly optimistic or pessimistic analysts. It also breaks down at the extremes of zero-growth or hyper-growth companies. Example PEG For example, if a company has a forward P/E of 20 with annual earnings estimated to grow 10% per year on average, its peg ratio is 2.0. Again, the higher the peg ratio, the more relatively expensive a stock is.instead.htmlinstead.html Evaluation of Financial Health Look for revenue growth. Anything can happen day to day, but in the long run, stock prices increase when companies are making more money, which usually starts with growing revenue. You'll hear analysts refer to revenue as the "top line." Check the bottom line, too. The difference between revenue and expenses is a company's profit margin. A company that's growing revenue while controlling costs will also have expanding margins. Know how much debt the company has. Check the company's balance sheet. Generally speaking, the share price of a company with more debt is likely to be more volatile because more of the company's income has to go to interest and debt payments. Compare a company to its peers to see if it's borrowing an unusual amount of money for its industry and size. Find a dividend. A dividend, a cash payout to stock investors, isn't just a source of regular income, it's a sign of a company in good financial health. If a company pays a dividend, look at the history of their payments. Are they increasing dividend or not? What Not To Do Don't buy on price alone. Don't assume a stock is a bargain just because its price has dipped 10%. Make sure you understand why and how that price is going to rebound. Don't rely too much on analyst recommendations. Analysts' reports can offer some great information on the health of a business, but be aware that they tend to be biased for 'buy' ratings. But because of that bias, a sell rating, especially a new sell rating, from an analyst can be a red flag. Keep an eye out for those calls. Don't be surprised by volatility. An individual stock is always going to be more volatile than a diversified mutual fund. Look at the 52-week highs and lows for stocks that you're interested in to get some perspective on how widely prices can swing within a year. Don't forget to sell. Of course, you should have a plan for how you approach buying stocks, but it's just as important to know when to sell. Have a set of criteria that will tell you it's time to sell: If the company cuts its dividend; if the price rises or falls to a certain point; if an analyst downgrades the stock, and so on. Having a plan for selling will help you avoid selling out of panic over a short-term move in the market. A plan for selling can also help you take your gains. How To Read Financial Statements=2&CN=COM=2&CN=COM What is Risk? Every investment carries risk We can use Beta Numbers to determine the risk of a stock. Beta Number: A calculation that helps measure the level of risk in investing in a stock. A Beta Number of 1 means that it will move with the market A Beta Number of more than 1 indicates the stock is more volatile than the market Basically the lower the Beta Number, the more stable. Risk Vocab Volatile/Volatility: The potential unpredictability or instability of a stock. A volatile stock is a risky stockone that can go very high, or very low Conservativefixed income and preferred stocks are considered conservative. Moderateinclude growth stocksparticularly young companies with great potential. Speculativestocks that are highly unpredictable. For example, many dot/com stocks are highly speculative, with incredible highs and devastating lows. Short Selling Short selling is the sale of stock borrowed from a broker It is a strategy often used when a buyer believes a particular stock will go down in value The difference in the price between when the stock was borrowed from the broker and when it was repaid would be the short sellers gain. If the stocks price rises, however, a short-seller will lose money because the borrowed shares will be repaid with higher-priced ones. Short Selling Example For example if an investor borrows 100 shares of a particular stock from a broker at $10.00 a share, selling it on the market at that price, the investor sees the stock drop to $5.00 a share and buys the 100 shares from the market to repay the broker making a $5.00 per share profit. This can be a risky transaction; if the shares go up to $15.00 per share the inves