Knowing cyclical, secular stocks is the trick to investing

Investing is a difficult endeavor.

Still, it’s a manageable task once the curtain of “arcane terminology” and Wall Street “gibberish” is pulled away, according to CNBC’s Jim Cramer.

“Investing isn’t easy, but it doesn’t have to be mystifying or intimidating. You just need to learn the lingo,” the “Mad Money” host said. “Know the difference between cyclical and secular growth stocks, recognize a sector rotation when you see one, and always, always, always stay diversified.”

Understanding whether a company is cyclical or secular helps investors determine how much a company can earn, Cramer said. It’s what drives the decisions that institutional investors, who influence the direction of the market, make to buy, hold or trade stocks.

Cyclical companies, such as machinery companies Caterpillar and Eaton, as well as commodity chemical companies such as Dow, depend on the business cycle and the strength of the economy in order to grow. When investing in cyclical stocks for the long run, investors must be prepared to stomach when these kinds of stocks decline during times of economic downturn.

“These cyclical players are, indeed, hostage — hostages to the vicissitudes of the economy. When the economy heats up, they earn more money, and we’re willing to pay more for those earnings,” Cramer said. “But when it slows down, they earn less money and investors pay less for their shares … and that’s why [traders] want to sell them ahead of time.”

Secular companies’ earnings manage to stay strong despite the overall health of the economy — think food, drink and medications. Cramer pointed to consumer staples Procter & Gamble and Colgate, food stocks General Mills and Kellogg and drug stocks Pfizer and Bristol-Myers as examples.

However, when the economy is heating up, the big fund managers tend to move, or rotate, their holdings from the secular growth stocks in favor of the cyclical growth ones.

“These are the classic recession-proof names that tend to outperform whenever the economy hits a rough patch and Wall Street suddenly develops a craving for safe, consistent earnings,” he said. “You don’t stop eating or brushing your teeth just because of a recession, or at least I hope you don’t.”

When getting started, Cramer suggests, investors begin by putting money into an index fund, which is a mutual fund — often tied to retirement accounts — that is a basket of publicly traded stocks designed to track a financial market. The most recognizable indexes are the S&P 500, made up of 500 securities, the Dow Jones Industrial Average of 30 large-cap companies and the tech-heavy Nasdaq Composite of 3,000 equities.

Index funds are especially ideal for the average investor who does not have the time or energy to commit to picking individual stocks and timing the right moment to trade them. Understanding how the stock market works also helps investors make money and avoid fees that Wall Street professionals charge for transactions, said Cramer, whose goal on “Mad Money” is to leverage his past as a $500 million hedge-fund manager to teach viewers how to make money on their own terms.

“The truth is, that’s the right call for many of you, and everyone should have some index fund exposure,” the host said, “but if you put in the effort, if you do the homework, then I believe you can manage some of that money as well as the pros.”

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