SOUND VIEWS – Q1 2024 A Lesson in Stocks

After discussing the role of cash and fixed income in a portfolio in our last edition, I’d like to turn to equities which are meant to be an engine of growth in portfolios. Equities, or stocks, offer ownership in the underlying company and in theory give the holder a claim on the future profits of the firm. Debt, on the other hand, usually involves the company owing money back to the holder of the debt. If the company keeps growing, the market may view that earnings growth as valuable and drive the price of the company higher. Typically, your upside when you own debt (a bond) is limited to the cashflow generated by the bond, whereas with a stock it can be 

unlimited. The downside to owning stocks is that there there are no guarantees you’ll get your money back, and if something happens to the company you could experience a significant loss. This is why stocks are thought of as long-term investments.

When we think about stock investing, it makes sense to divide the world into pieces. There are many kinds of stocks available for investors, ranging from high-growth small companies to large dividend paying value companies to more volatile emerging market stocks.

Among the most common ways of separating stocks is by the size of their market capitalization, large, mid, and small. Market capitalization simply means the price of a stock multiplied by the total number of shares issued by the company. Some of the largest stocks like Microsoft and Apple find themselves in widely followed indexes like the S&P 500. Smaller companies have their own distinct characteristics and can offer diversification benefits, but also may come with further risk.

 

Another common way of looking at stocks involves the geographical breakdown by developed, emerging and frontier markets. Great Britain, Japan, and Germany are the types of countries thought to be in developed markets. Places like Thailand or Brazil are often found in emerging markets. Finally, frontier markets are even less developed than emerging. As an old joke I used to tell clients that developed markets are where you travel when you retire, emerging markets are where you travel when you’re young, and frontier markets are where you travel when you’re filming an adventure show. Each of these can play a role in a client’s portfolio depending on their risk tolerance. This pie chart from MSCI shows even when you invest internationally, the U.S is still a big player. It is important to keep in mind that there are currency differences with many of these countries and each country carries its own risks.

Finally, sector and style weighting are also among the common ways to think of investing in stocks. Sector investing separates companies by the industry in which they occupy like health care or technology. This can be useful if you’re trying to express a certain view on a sector or balance out an investment you know excludes a sector. The technology sector gets a significant amount of media attention but a quick check of the various sectors shows a wide variety available for investment. Knowing which sectors your investment strategy focuses on, and avoids, can be key to your success.

Style investing seeks to take this a step further by organizing investment by the characteristics of the stocks themselves. As an example, a company with a high earnings growth rate may be considered a “growth company.” A company with a low price-to-earnings number, its share price relative to its per-share earnings, may be considered a “value company”. There are a myriad of style investing options and some that combine various types of style.

There is no shortage of options for investing in equities including buying individual stocks, mutual funds, both index and non-index based exchange traded funds, and separately managed accounts for larger sums of money. Choosing the right way to access equity investing is often just as important as making the investment itself. We can help guide our clients, not only on what to buy if owning stocks is right for them, but also on the best way for them to do so.

MSCI World Index

 

The MSCI All Country World Index (ACWI) is an index made up of stocks from nearly 3,000 companies and 47 different countries. It’s a widely recognized benchmark and designed to be a broad representation of the market globally.

Download their PDF fact sheet at:

*https://www.msci.com/our-solutions/indexes/acwidirectly in an in

 

This material should not be construed as investment advice or relied upon as a basis for any investment or financial decision and does not constitute an offer or solicitation of any kind. It is not possible to invest directly in an index.

 

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