The continuing bull market in equities has inspired personal finance websites to unleash a cacophony of articles on the next blockbuster stock. Reading these websites might tempt you to believe that investing is all about finding the next Apple and cruising on it an early retirement. Think again. Truly savvy investors know not to lose sight of the big picture and run after individual stocks. They realize that the global economy is a huge, complex beast made up of interdependent industries and sectors, and that the best investing ideas often come not from going into the nitty-gritty of company financial statements, but by watching the currents in the broader economy and picking groups of companies that can benefit from them. Stocks of companies in the same sector often tend to move together, which makes sector selection a more efficient way to pick investments.

How to pick a winning sector

There are a number of ways in which a sector can come into favor with the markets.

Cyclical sectors
Some sectors are cyclical in nature. They tend to do well when unemployment is low, real estate and stock markets are healthy and factories are busily producing output. Think of apparel companies or household appliances makers that are dependent upon consumer sentiment and income. Other companies do well when businesses overall do well. Aircraft makers such as Boeing that see a surge in orders when the airline industry does well fall in this category.

The start or middle of recovery from a recession is usually one where cyclical sectors are poised for growth.

Technological breakthrough.
A significant new technology often acts as a game changer in pulling up an entire sector’s valuation. The advent of the Windows operating system in the mid-90s and the spread of the internet not only gave birth to the software sector but also recharged the semiconductors sector. When a successful new technology is marketed by a company, the stock prices of its suppliers and distributors also rises.

If there is a new technology that you are bullish on, be sure to look at not only the company that manufactures it but also the supporting network of companies that help bring it to market, i.e. the sector that supplies, services or distributes the technology.

Opening of new markets.
Sectors that face stiff competition at home often get a boost when they are able to enter new markets abroad. Fast food chains like McDonalds faced a growing tide of public disapproval about the nutritional value of their menu in the early 2000s in the US which affected its stock price. At the same time, fast food retailers had started making inroads into emerging markets from China to Eastern Europe. Eventually their stock price caught up to the reality of their enormous potential in foreign markets outweighing declining sales at home.

Consolidation
Sectors where cash-rich companies are buying out their struggling competitors see an increase in their overall valuation because consolidation leads to higher profitability for the survivors.

Once you have identified a sector that you think is poised for stock price growth, you can pick well-run companies or companies with large market share within the sector. Another way to get exposure to the entire sector is by purchasing sector ETFs. Vanguard, iShares and many other reputed ETF companies sell ETFs that can provide this exposure in a tax-efficient manner. Many of these sector ETFs provide exposure to international companies in addition to domestic ones.

Always keep the big picture in mind when picking investments. Sector selection is often more straightforward than individual stock selection and helps keep your holdings diversified.

Dividend investing (or income investing) refers to stock investment for the specific purpose of earning income through dividends. While receiving a steady stream of income is always attractive to retirees, why would a younger person bother with dividend investing? Simple enough, a bird in hand is worth two in the bush, a penny in your brokerage account is worth three in potential future stock price increase. After the recent uncertainty in the markets, there is renewed interest in dividend investing because it is a strategy that seeks to reduce uncertainty around returns by buying stocks of companies that believe in handing out dividends. Another great thing about dividends is that they grow over time. Dividend Growth has exceeded inflation by 2% annually over the past 85 years. While the quarterly dividend per share in the S&P 500 was $1.05 in early 1977, it has risen to over $7 by 2008.

Is it for you?
Dividend investing can have a place in your portfolio if your goal is to receive steady income during down markets. Dividends when reinvested in other dividend-paying stocks can set up a virtuous cycle of cash-spouting investments. During a bear market, when everything is going down, you will be reassured by your dividends. Dividends are less volatile than stock prices and dividend-paying stocks can be particularly stabilizing in a college savings account, for example. To save on taxes on dividend income, consider buying dividend paying stocks in tax-advantaged accounts such as IRAs.

How to pick companies for dividend investing.
The most famous dividend investor of them all (even if he doesn’t call himself that) is Warren Buffet. Buffett picks companies that offer a steady dividend rather than hoard their extra earnings for future projects. This includes companies such as Coca Cola (KO) and American Express (AXP). One of the criteria he uses to pick companies to invest in is their ability to raise prices to increase revenues, i.e. companies with an unbeatable competitive advantage. Since excess revenues directly boost a company’s ability to increase dividends, this is a great way to evaluate companies.
Another way is to evaluate companies based on their stated dividend policy. Some companies (such as Google) consider reinvesting their excess earnings to be a better use of capital than giving out dividends. Such companies don’t fit the dividend investing profile.

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