More Good Info About Diversification!
Avoid concentrating all your money in any single stock
or type of issue.
Few stocks perform like Microsoft, which has doubled, on
average, every 14 months. Nor are all investors beating the
bushes to find the next Microsoft. Why not? Because for
every stock that delivers turbocharged returns, there are
hundreds or thousands that simply dry up and blow away. So
rather than risk plowing all their money into the next
high-tech train wreck, most people fill their portfolios with a
variety of different types of stocks that have different
profiles of performance. Here are five of the major types:
Growth stocks. Microsoft is a classic growth stock --
but any stock with rapidly rising profits fits the bill.
Typically growth stocks trade at price/earnings ratios
that are equal to if not greater than their expected
growth rates (for more, see "Identifying bargains").
While growth investing can be highly profitable, it can
also be risky because the same investors who love a
stock when its earnings are expanding smartly may bail
out in a hurry if the growth rate slows. That, in turn,
can drive the stock's price through the floor.
Momentum stocks. Think extreme growth investing.
Momentum investors buy stocks in companies with
earnings that are growing at increasingly higher rates.
Indeed, some momentum investors will buy a stock
simply because its price is going up. This can be a very
lucrative investing strategy, but it only works for limited
periods of time (as short as hours to minutes, for some
day traders). The risk is that it's tough to pick when
that time will end. And when the music stops, as it
invariably does, anyone left holding an unloved
momentum stock could see its value disintegrate.
Value stocks. Another way of saying "cheap stocks."
These are simply issues that are undervalued compared
to their real earnings potential. The market is down on
them because their earnings have taken a temporary
hit, their product line is in a momentary lull, or some
other passing event has knocked their price down. The
key word here is "passing." A value investor bets that
whatever ails these companies will end, and that --
given enough time -- their price will rise to reflect their
true value. Oddly, value stocks are sometimes growth
stocks that are past their prime. For example, IBM, one
of the great growth stocks of the 1970s and '80s, fell
from grace in the early '90s after several years of
disappointing earnings. But some value investors
determined that the company's earning power was
much greater than Mr. Market was giving it credit for.
Over the next few years, as that proved true, other
investors clambered aboard, and the company became
a growth stock once more.
Cyclical stocks. Some stocks, like those of steel
makers or oil producers, are considered cyclical
because their companies' services or products aren't in
constant demand throughout all parts of the business
cycle. For example, steel makers see sales rise when
the economy heats up, spurring builders to put up new
skyscrapers and consumers to buy new cars. But when
the economy slows, their sales lag too. And steel
stocks, which rode up on as investors anticipated the
boom, ride down on expectation of the bust. Investors
in cyclical stocks are typically betting on the direction
of the economy.
Income stocks. Stocks that pay relatively high
dividends, like utilities and real estate investment trusts
(REITS). Income stocks are generally favored by
conservative investors who want a steady stream of
cash from their investments and count on the dividends
to buoy the stock's price if the market takes a spill. Not
all high-dividend stocks are good investments,
however. If a company's stock falls because of poor
performance, its dividend, when expressed as a
percentage of its stock price, appears to shoot up. But
if the performance continues to drag, the company may
have trouble paying the dividend and be forced to cut
or eliminate it altogether. In that case, the final prop
for an already troubled stock will be knocked out.
If you only began investing seriously over the last few years,
you probably haven't given dividends a second look. After all,
many of the great stocks of the early to mid '90s, like Dell,
Microsoft and Cisco, didn't even pay dividends. And between
1990 and 1998, the aggregate dividend yield on the Standard
& Poor's 500-stock index fell from 3.7 percent a year to as
low as 1.4 percent. Why? The simplest explanation is that
many companies just didn't have to offer dividends in order to
get investors to buy their stock. After all, what's an extra 1.4
percent when the market is posting double digit gains year
after year.
Well unless our depleted ozone layer is replaced with laughing
gas, the stock market won't post double-digit gains forever.
And whenever that happens, dividends are likely to resume a
more important role. Indeed, nearly half of the market's 10.9
percent average annual gain between 1926 and 1997 came
from reinvested dividends.
Dividends can also offer a clue as to where management
thinks a company's earnings are headed. To understand why,
consider what a dividend actually represents. Once a year, a
company's board of directors votes to distribute a portion of
its profits to shareholders. In doing so, they are, in effect,
casting a vote of confidence in the business's long-term
earning power. If the outlook is glum, chances are they'll cut
the dividend or eliminate it, so the company can use the
precious cash for more pressing needs. But if the outlook is
good, and even despite any near-term difficulties, they'll vote
to maintain or even increase the payout. |
