Is your share portfolio a dud?

It takes a while for investors to cotton onto the fact that investment booms are happening every day – somewhere around the world. By the time the last property boom had run out of puff in Australia, the commodities bull was well into the swing of things and canny investors had already smelt out profits to be made.

When an abundance of funds flow into a particular sector, stock or industry, investment booms occur. Think of these flows like water channelling through pipes or canals and you’ll get a feel for how money moves through the system causing booms and busts, high tide and low tide.

The challenge is to detect this fund flow and predict its movement for a handy profit. This is easier and harder than it looks.

Have you profited from the recent resources boom? Have you held shares in companies that have profited from strong commodities prices, or the booming economies of India and China that have driven demand for our resources? Has your share portfolio ever held Australian property trusts? For many years the Australian property trust sector actually outperformed Australian share investments. If you weren’t exposed to these booming sectors then you have clearly missed out.

Many years back before the gold boom got underway, a gold expert relayed to me his retirement plans. After having studied the movements in the gold price for more than 15 years, he proclaimed that this was the boom of a lifetime, and without delay every available cent of his retirement savings was placed into gold or gold-related investments. How did he go? Put it this way, the gold price has doubled since mid 2004.

Not everyone has the time to be an expert in a given field. Even if we’re an avid enthusiast of gold, resources or property, we may not have the nous to see the boom before it’s too late, the conviction to back our predictions and the bravery to see the boom through its bumpy times.

To overcome our limitations or simply a dearth of good luck when it comes to investing, a well-constructed portfolio can be our saviour at the end of the day. If designed correctly, your share portfolio can ensure that you are invested in the right place at the right time.

Last week we looked at the issue of diversification and discussed exchange traded funds (ETFs) and index funds as a quick fix for those wanting diversification in a portfolio. These products offer exposure to the broader market – such as all stocks in the S&P/ASX 200 index.

The importance of diversification doesn’t end there, however, but extends into the manner in which we choose stocks. We certainly aren’t encouraging you to buy an index fund or ETF and be done with it. Hardly.

As we mentioned last week a good-sized share portfolio will hold around 10 to 15 stocks. And these stocks should be a nice mix of small and large capitalisation companies spread across a variety of sectors and industries.

This week we’ll look at blue chip stocks, which are often used by investors as core holdings in a share portfolio, plus outline the difference between cyclical and defensive stocks.

Blue chip stocks

Solid, reliable companies with a history of rising profits and dividend payments are often called blue chip stocks. BHP Billiton, National Australia Bank, Qantas, Westfield, QBE Insurance, Woodside Petroleum and Foster’s Group are typical blue chip stocks. Blue chips are large established companies with stable earnings and minimal volatility.

The S&P/ASX 50 – consisting of the largest companies in Australia based on market capitalisation – holds many of Australia’s most well-known blue-chip stocks. (As a quick recap, the market capitalisation of a company is calculated by multiplying its current share price by the number of shares on issue.) Companies such as Telstra, CSR, Boral, Brambles, Alumina, Suncorp Metway, Rinker Group and Mirvac Group are the types of companies found in the S&P/ASX 50 index.

Although it’s probably wise to include many blue-chip stocks as core holdings in your share portfolio, don’t overestimate the power of a blue chip. There have been many instances of wallowing share prices of blue chips stocks; take Telstra for instance. Or blue chip stocks that have shocked the market with plummeting share prices, such as AMP. Its shares fell from a lofty height of $20 to $5 between 2001 and 2004. The now defunct energy firm Enron in the US was once regarded as a blue chip stock.

Cyclical stocks

Some stocks perform well when the economy is going gangbusters, but tend to do poorly when the downturn arrives. Cyclical industries include raw materials such as steel, building materials, media and airlines (people travel less frequently during less prosperous times). Typical cyclical stocks in Australia are building materials companies CSR, Boral and James Hardie Industries that track the construction cycle, and John Fairfax Holdings in the media sector that’s heavily reliant on a strong market for advertising.

Having cyclical stocks in your portfolio during prosperous conditions is often a smart bet as these companies can significantly boost earnings during buoyant times.

Defensive stocks

Defensive companies are the types of stocks that can do well during both good and bad times. Financial services companies such as the big banks, healthcare stocks and consumer stables such as Woolworths tend not to suffer as much during economic downturns. People visit the doctor, purchase pharmaceuticals, buy milk and bread and other consumer items regardless of whether the market is hot or not. For this reason defensive stocks tend to outperform the broader market during less exuberant times.