The stock market has all kinds of indices to gauge market growth and sentiment. We all know the Dow Jones Industrial Average (NYSE: DJI) and the ASX All Ordinaries (ASX:XAO). You too can make your own index of companies from a particular industry, to search for times when a stock is overlooked and unloved. This may be a source of finding good stocks that are out of favour.
Identify the top two or three companies of an industry, and keep track of their movements by charts. Or simply add their share prices together, and note where they make lows and highs. This can help focus your company research, when you are wanting to add to your portfolio.
Although depressed earnings is usually the main culprit in bringing down the price of major companies, market sentiment towards that industry may unduly send the price further down, because of the psychological aspect of investing. In the short-term, the market is like a beauty contest, so when prospects become unattractive, many investors move on.
Here are three industries and their market leaders:
Mining: The two biggest in the ASX are BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO). They both recovered from GFC in early 2011, but since then the mining industry has been slipping, due to the concern that China would be slowing down.
The share price of the two dropped, until better reporting data from China showed that the world wasn't going to end, and they had to start buying inventories for their own production. Both are reporting higher volumes of iron ore shipments, and iron ore spot prices are improving, so earnings should go up. Are they fantastic now? No, but you may have an opportunity to add it to your portfolio as it builds up.
Insurance: The biggest insurance companies are Suncorp Group (ASX: SUN), QBE Insurance Group (ASX: QBE), AMP (ASX: AMP) and Insurance Australia Group (ASX: IAG). As a group, their share prices flattened out in 2011, reflecting the somber economic mood at that time. They also had to weather some natural disasters occurring, leading to insurance payouts rising and earnings shrinking.
Since July 2012, the majority of these companies have been rising steadily. When the market was at its worst, that would have been the time for investors to begin making their shopping list of quality stocks.
Capital Goods: Leighton Holdings (ASX: LEI), Monadelphus Group (ASX: MND) and UGL (ASX: UGL) are some of the big names in infrastructure development and engineering. Since Leighton Holdings is about 4 times larger by market capitalisation, than the other two individually, its movement holds more weight, but as a group you can still see that in early 2013 all of them started to drop in share price.
This was due to the mining industry downturn, causing miners to cut back on developments and expansions. Those cutbacks meant fewer and smaller contract awards to engineering and infrastructure companies. Now would be the time for investors to start looking over these and other smaller companies in this industry group. Begin by sorting out those with a durable competitive advantage, that can weather a longer industry slump, and will come out stronger when the market turns.
The Foolish Takeway
Selecting good quality companies is not just about share price movement. As soon as one stock goes up 10%-20%, it could fall just as easily back down if one bad report is released. It's best to focus your attention on a group of successful companies, and use that as a reference for your research. Just because this article concentrates on the larger companies doesn't automatically mean that they will have the greatest shareholder returns.
When the share market is depressed about an industry, investors and traders seek hotter stocks in search of quick profits. You want lasting value in your portfolio, so build in a margin of safety against a sudden market correction, and you'll thank yourself years from now.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
