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The "bottom-up" approach to investing involves grouping potential stock picks by general categories, such as industry, market capitalization or index
There are so many thousands of public companies that finding a place to begin stock picking can be overwhelming. Fortunately, stocks can be categorized in various ways, of which the most common are sector or size. Classifying Stocks by SectorIt is possible to narrow the stock search by only focusing on the sectors which appeal, i.e. those that are already known and understood, or those that carry the appropriate level of risk. While each company should be assessed individually, it is fair to say that some sectors are inherently riskier than others. For instance, the gambler may decide to invest in a mining exploration company. If it strikes gold, the investor will have hit the jackpot. On the other hand it might explore for years and never find a commercial deposit. The investment could turn out to be worthless. Other companies, like those in the food or banking sectors, are geared toward building up steady growth in sales and profitability. This should generate steady returns for investors, which is considered lower risk. A list of sectors follows:
Classifying Stocks by SizePublic companies are also commonly split into groups depending on their size or market capitalization (this being the value of all the shares on the market). For instance, ABC Plc has 10 million shares in issue worth 200p each (this is the mid price or the halfway point between the bid and the offer). The market cap is therefore £20 million. The size of the company can make a big difference to the investment return. Large stocks are generally bought for low capital gains (the value of the investment) and high income (dividend payments). Smaller stocks are bought for high capital gains and low or no income.
Classifying Stocks by IndexBased on these two criteria – sector and size – various indices can be formed. For instance, the FTSE 100 tracks the largest 100 companies in the UK by market capitalization. The five biggest FTSE companies are currently: BP (oil & gas), HSBC (banking), Vodafone (mobile telecoms), GlaxoSmithKline (pharma & biotech), and Royal Dutch Shell (oil & gas). This article is part of a series. To see more, visit: Interpreting Financial Accounts How To Create Stock Valuations
The copyright of the article How to Classify Stocks in Shares/Stocks is owned by Rebecca Turner. Permission to republish How to Classify Stocks in print or online must be granted by the author in writing.
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