Methodology

Stocks

Module 2

Why does the sector that a company operates in, impact upon their stock price?

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Sectors

Sectors

The sector that a company operates in can have a significant impact upon the performance of its stock. This is because some sectors have more opportunities for companies to grow in than others. There are a number of different industries, including finance, hospitality, healthcare and agriculture (among many more), with each industry having its own characteristics – which can have an impact on the performance of a stock.

 

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. The emergence of the internet, for instance, has led to an endless amount of opportunities for technology companies. The way that people use the internet is always evolving. It started with simple tasks, like sending and receiving emails, and now is focused on developing smart technologies that integrate the internet and ordinary tasks, like exercising.

 

This is a positive scenario for investors in large technology companies, as it means that they always have opportunities to grow. The downside, however, is that the companies need to work hard to keep up with the latest technology – which is a big risk for an investor if they don’t.

 

Most sectors are not like technology and have less opportunities for growth. This is the case as consumers have not changed the way that they behave within a sector or as a result of a lack of innovation. This lack of development leads to a stock price that grows at a slower, more stable rate.

The economy and sectors

Investors use sectors to group stocks together that share similar characteristics. It helps to give them an idea of how well one part of the economy is performing in relation to another part. By knowing which sectors are performing well and which are not, an investor can focus their attention on certain areas to improve the performance of their portfolio.

 

Certain sectors will perform well or badly depending on the state of the economy. When things are going well and the economy is expanding, companies that produce raw materials, for instance, tend to perform well as other businesses are opening and require those materials to manufacture products to sell. When things are not going so well and the economy is shrinking, companies that sell essential consumer items tend to perform well, as people are struggling financially and usually focus their spending on items that they really need.

 

This approach to investing is useful because it helps an investor to make decisions that are based on the economy.

Risk and Sectors

From the viewpoint of an investor, there are risks associated with the sectors that they decide to invest in. If a sector changes quickly, there is likely to be a lot of competition between companies that operate within it, which increases the likelihood that businesses will go out of business. As stated before, if companies do not keep up with consumer demands or continue to innovate, then they could decrease in value significantly.

 

On the other hand, if a sector does not change quickly, the stock price of companies operating within it will be very stable. This can sometimes mean that such companies grow in a consistent manner, but it also means that they may not grow at all.

 

As a consequence, an investor should deal in sectors that suit their tolerance for risk. A sector that changes quickly, like technology, would not suit an individual that is risk averse. At the same time, more stable sectors would not suit an investor that aims to grow their portfolio very quickly, with more risk.

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