To get the best from your portfolio, you need to know your stocks. Here's how one great investor splits them up.
In One Up On Wall Street, the famous American investor Peter Lynch described how he split stocks into six categories. Last issue we looked at sluggards, stalwarts and fast growers, which are, generally speaking (and particularly the sluggards and the stalwarts), the less risky categories. Now it's time to move on to cyclicals, turnarounds and asset plays. These categories can offer lucrative opportunities, but they can also deliver crushing financial blows when you get them wrong.
If the sharemarket were a sporting competition, these stocks would be reserved for 'A grade' players only. Unfortunately, though, the market is not separated in this way and beginners are not protected from blowing up their life savings on a cyclical stock bought at its peak, or on a turnaround that doesn't turn around.
Cyclicals
Most businesses have a cyclical element to their operations. Even so-called 'defensive' businesses generally benefit to some degree from a booming economy and suffer when things turn sour. But some companies are particularly exposed to the ebbs and flows of a business cycle, and these are known as cyclicals. The most commonly encountered cyclical stocks are probably those exposed to discretionary consumer spending. These businesses are hardest hit when unemployment or interest rates rise and consumers tighten their purse strings.
This is a particularly dangerous area at the moment. As our national Treasurer often reminds us, we're currently enjoying the longest period of continuous economic expansion ever recorded, and this dream run has masked the inherent cyclicality of many businesses. Indeed, the chief executives of most Australian listed companies have yet to lead their organisations through an economic downturn.
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