Stocks that are listed on a stock exchange are not all the same, the have different characteristics.
Those characteristics can have a significant impact upon the performance that you might expect from a stock.
When making investments in the stock market, it’s important to be aware of those differences as they should play a role in determining what stocks you buy and what stocks you try to avoid.
With that said, it’s not necessarily the case that there are good and bad characteristics, it often depends upon the approach taken by the investor.
For instance, if someone is more open to taking big risks, they may select stocks that are totally different in terms of characteristics, when compared to an investor that is more risk adverse.
A key characteristic that has an impact upon stock market returns is company size.
Smaller companies tend to be more volatile that larger companies. This means that the stock price of a small company can increase and decrease more drastically than larger companies.
For example, the stock of a smaller company may grow by 50% in a single year, while the stock of a larger company may grow by just 5%.
Equally, when the economy takes a hit, the stock of a smaller company may fall by 50%, while a larger company may be more stable and the stock price may fall by just 5%.
In short, smaller companies are less stable than larger companies.
This may seem like an attractive proposition for a lot of new investors but smaller companies are much more likely to go out of business.
For that reason, the smaller the company, the more risky the investment.
Linked to the size of companies, the development stage of a firm is a key characteristic that impacts upon stock market expectations.
There are 4 stages of development for a company: Startup, Growth, Maturity and Decline.
Much like with size, the earlier a company is in the development cycle, the more volatile it is as an investment.
Arguably the stage that most investors are fearful of is the decline phase. This is when a company is starting to fail and will eventually go out of business.
It’s incredibly hard for a company to survive in the long term (sometimes 100+ years) and so it is often the case that companies will eventually go out of business.
There are many reasons why this could happen but a key reason is that consumer behaviour has changed.
A key example would be BHS (British Home Stores), which went out of business in 2016 after originally opening it’s doors in 1928.
Aside from the mismanagement of Arcadia Group, BHS went out of business because of changing consumer behaviour. Each year the company was losing market share to internet companies as the high street became less and less competitive.
Most of the companies listed on the stock market are in the Growth and Maturity phase. Mature firms deliver less on stock market and are much more likely to offer a dividend. Growth stage companies, like Amazon, offer tremendous returns for investors.
Whether you should invest in Mature firms or Growth stage firms, depends upon your goals as investor, do you want to grow your capital or are you investing for income?
The answer to these questions typically relate to your age. Younger investors usually want to grow their capital, while older investors want to top up their income for retirement.
The sector that a company operates in can have a significant impact upon the performance of it’s stock.
This is because some sector has more opportunities to grow than others.
Technology is widely considered to be the best performing sector in terms of stock market returns, which is the case because consumer demands are constantly changing.
This means that the sector has numerous opportunities to grow the size of the company.
At the same time, as consumer demands are always changing, the sector is less stable. As a consequence, technology companies may go out of business more easily if they fail to remain competitive by continuing to offer value to consumers.
For example, Nokia was the leading mobile phone provider before Apple released the iPhone. As Nokia failed to keep up with the latest technologies, they lost considerable market share to the likes of Apple and Samsung. As a result, Nokia became less valuable over time.
To illistrate this point, before the iPhone was released, Nokia had a stock price of 27 EUR per stock. Today, in 2020, Nokia’s stock price is just 2.89 EUR.
It is also the case the different sectors thrive at different times during each economic cycle. Luxury consumer brands, for instance, will perform strongly when the economy is strong but will perform terribly when the economy is weaker.
After a recession, financials will perform well as they play a key role in helping the economy to recover, but not so well when the economy is at it’s strongest.
Identifying where we are in the economic cycle is tough. If you can get it right though, selecting companies in the right sectors can be very profitable.
Finally, whether a company operates globally or domestically can have an effect upon stock market returns.
Companies that operate globally are less likely to be effected by events within a single country. Therefore, if something significant happens politically in one country, a global company will be effected less by such events.
Aside from the obvious fact that they operate in multiple countries, global firms are able to hedge currency risks.
A key example would be when the UK voted to leave the European Union. When the result was announced, the FTSE100 decreased in value by around 20% in a single day.
Domestic companies suffered greatly, while international companies actually thrived.
BP stock, for example, increased by around 20% following the Brexit result, benefiting from weaknesses in the British pound.
The oil business operates in US dollars so the profits of BP grew significantly due to the currency exchange rate between the two currencies.
Before the referendum, $1 was roughly 70p. After the referendum, $1 became roughly 82p.
This essentially means that the profits of BP grew by 12p almost over night.
In summary, if investors buy stock in global companies, they are much likely to be affected by domestic issues in a single country. The extent to which domestic issues affect a global company, depends upon the percentage of business they do in that country.