Identify Stocks on Sector Based Approach

January 30 , 2013

As a person in the financial field, I am often asked some good stock ideas. People assume that anyone in finance should have a bunch of such tips ready (besides a ready view on where the market is going). Such 'stock tips' also make for interesting party conversation. Of course, tips are now peddled through all possible sources – newspapers, websites and even SMS. However, in the absence of any systematic methodology of research, this is just the newspaper's word against mine against what the SMS said. It is no different from watching a slot machine with bated breath - somebody will win once in a while, but nobody will be the wiser on whether this has any value for making future predictions and decisions.

One systematic way to get to this is to look at sectors first. Sectors are somewhat more predictable and stable than individual stocks. They also make for a more considered research methodology. After having identified the reasons for choosing a sector, individual stocks within this could be chosen.

Let us look at some examples:

  • The FMCG sector depends on rural demand for its products. A good monsoon and a well performing agricultural sector could bring good times for FMCG
  • The IT sector predominantly depends on exports. A weak Rupee is one factor that could help this industry, since its costs are largely in Rupees while billing is in foreign currency. Thus, the exchange rate would be one variable to watch for, in tracking this sector.
  • Consider the cement sector. Cement demand comes primarily from the construction and infrastructure sectors. Thus, a watch on the outlook for these sectors could give a leading clue on how cement sector is likely to perform.

Most listed real estate companies in India focus on middle and premium real estate. This demand comes from growth in white-collared jobs and salaries, often in the IT and Finance sectors. Reports of good job growth and salary increases in these sectors could herald good times for real estate. Interest rate is another variable that affects real estate, since a lot of it is bought on loan.

It is no one's claim that this list is exhaustive or completely accurate. Indeed, there are several other factors that go to influence how a sector performs. Yet, this can be a useful starting point. From here, you could track a couple of sectors in more detail, and progressively refine the driver variables you have identified. Most of these variables are drivers, so the impact on the sector could slightly lag the movement of the variable. This is precisely the window of opportunity for you to enter and make your bet. If you are diligent about it, you will find yourself gain more often (though not always).

Remember though - the key is in identifying the variables and trends before they become hot news in the media. Otherwise, you are likely to be a mere camp-follower, rushing in after prices have already risen and the smart guys have already made their buck. I know several people who entered real estate after DLF and Unitech had hit stratospheric levels in late 2007, only to lose their shirt shortly thereafter. But the investors who saw the real estate story play out before it became hot property, have managed handsome earnings.

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