The first step in picking winning stocks and avoiding the losers

Firstly, there are several warnings I need to make. I’m not going to recommend any stocks to buy as they may not suit your personal needs. I’m not going to tell you how to structure your share portfolio (well, unless you ask, and then I’ll only give you some general suggestions of what I might do).

So, lets jump right in. How do you know which stocks to buy and which to avoid?
Well, I’m glad you asked, because I’ve listed below my criteria and why.

Read more of this post


Upcoming blog ideas

I’ve got several ideas for blog posts, including the following: –

  • Criteria to picking winning stocks and avoiding losers – I’ll tell you my criteria for picking stocks to invest in
  • A comparison of valuation methodologies – which one is the most accurate?
  • A discussion of technical analysis – where’s the technical analyst equivalent of Warren Buffett?
  • Basic finances 101 – the importance of budgets, getting your financial structure right etc
  • A reading list – several books I’ve read or want to read and why you should read them as well
  • Warren Buffett’s tenets
  • How you can easily beat the superfunds with some simple tips
  • CFDs, Derivatives & Futures – why to avoid them
  • The importance of dividends
  • Trusts, different types and the advantages and disadvantages. How to setup your own Trust and why you would want to
  • Moats and competitive advantages
  • Porter’s 5 forces

If you have any other ideas you’d like me to write about, please let me know.

Cyclical stocks

If you’ve read Peter Lynch’s book “One Up on Wall Street”, you’ll know that he classifies stocks into 6 categories. Slow growers, fast growers, stalwarts (medium growers), asset plays, turnarounds and cyclicals. Today I’m going to discuss cyclical stocks.

Cyclical stocks generally refer to those stocks whose profits move up and down depending on the state of the economy. This means that as exchange rates, interest rates, unemployment, GDP jump or fall, these all have an effect on the economy.

Examples of cyclical stocks include resources and mining services companies, speciality retailers, media companies, airlines, steel and construction companies.

The opposite of cyclical stocks are non-cyclical stocks, or as they are more commonly known “defensives”. These companies will generally have consistent performance (and hopefully profits), no matter what happens to the economy.  Examples of defensive stocks are grocery retailers, healthcare companies, real estate trusts, telecommunication companies and utility companies (i.e. those that supply, electricity, gas & water). Think of these companies as supplying “essential” services, those we can’t live without.

However, these classifications are generalisations only and companies do not strictly adhere to the rules, e.g. Multi-national companies can be affected by different economies at the same time and defensive stocks can be affected by non-economic cycles.

Cyclical stocks are harder to value than defensive stocks, as their profits can be volatile from one year to the next. When considering a company to invest in, determine if it’s a cyclical stock and if you can, where it is in its cycle. If you only look at the companies very recent performance, it might appear to be a fast growing stock, or a defensive stock, but if the economy turns down, the fortunes of the cyclical company are likely to follow it.

So, how do you identify a cyclical stock?
If it doesn’t produce essential products, if it’s in the list of sectors above, if its long-term historical performance is volatile, then its most likely a cyclical stock. Below is my attempt to categorise the top 20 Australian companies as defensive or cyclical stocks.

BHP, RIO, NewCrest (NCM) & Woodside – cyclical. Profits are mainly influenced by commodity prices, which are mainly determined by supply and demand.
Banks (ANZ, CBA, NAB, WBC & Macquarie) – cyclical. Profits affected by the state of the economy
Brambles – cyclical. Could also be classified as a slow grower or a stalwart I guess.
CSL – defensive. CSL sells blood plasma products which follows supply and demand for the product, but it seems to be in constant demand.
Fosters – could be both. If the economy turns down, people can tend to drink more wine, beer & spirits, thereby raising Fosters revenues.
Origin Energy – defensive
QBE Insurance, AMP & Suncorp – defensive. People still need car, house & life insurance, no matter what the economy is doing.
Telstra – defensive. people still have to pay for their phones, will still make phone calls.
Wesfarmers – is a conglomerate so has features of both cyclical (Coal) and defensive (Coles) stocks
Woolworths – defensive. Probably the most defensive stock in the top 20.  People will still need to buy groceries. They might switch to cheaper products, but will still shop at Woolworths.

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