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Wednesday, March 23, 2016

Top-down Analysis: Finding the Right Sectors and Stocks

The stock market seems to be recovering from a year-long correction. Experts and analysts are suggesting that the next leg of a long-term bull market is about to unfold.

This is a good time for new investors to start building an investment portfolio. Note that I haven't mentioned anything about buying stocks just yet. 

Building an investment portfolio that will generate inflation-beating returns for many years requires careful planning and analysis. So, how should you begin the process?

Ideally, you should get in touch with a financial planner who will hand-hold you through the process of preparing a financial plan based on your current and future earnings and financial commitments.

Another option is to spend some time on research about how to prepare a financial plan, and do it yourself. It is not rocket science. Basic math skills and accounting knowledge is good enough.

Next, properly assess your risk tolerance. There are tools available to do such an assessment.

Based on your financial plan and risk tolerance, an asset allocation plan should be prepared. What is the necessity of an asset allocation plan? 

It diversifies your investments among different asset classes - like equity, mutual funds, fixed income instruments, gold - to enable better returns under different market conditions.

Now you are ready to build your investment portfolio according to your financial plan, risk tolerance and asset allocation plan.

To beat inflation, you have to invest in equity shares. It is not just about opening trading and demat accounts. You need to know which stocks to buy. 

For that, you need to go through another process, called Top-down Analysis - where you figure out how the economy is doing and which sectors are likely to perform better during the next leg of the bull market.

It helps to have some knowledge of the business processes in the identified sectors. 

If you have identified FMCG sector as a potential money-spinner due to the thrust on rural income by the government, you need to know that companies in the sector typically have huge advertisement costs, strong cash flows, low capex, well-known brands, high P/E, low growth, good dividend payouts.

You can choose the top two or three companies based on their rural distribution reach. Repeat the exercise for three or four more sectors to get adequate diversification. 

Now you have 10-12 stocks from three-four sectors for the equity part of your portfolio.

Read more about Top-down Analysis here.

Related Post

How to Pick Stocks for Investment - Part II

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