Your stock universe - A guide to selecting investment
When investing (or trading) in
shares in any share market, there are many to choose from. In
Australian share market alone, there are more than 2000
equities to choose from - including both companies and ETFs.
how can you decide which of these to invest in? Across all of
available equities, there are a number of different characteristics
which might help you to make your decisions.
investors and traders will firstly compile a list of equities which
they will call their own "stock universe". Then they will make a
selection from that list based on a variety of other criteria. The
important point here is that having compiled a "stock universe" list,
they will tend to ignore any equities that are not on the list.
compiling such a list, it will simplify the investment decision
process, and help to reduce some of the distractions that can cause
Stock selection - two step process
Many investors and traders will do two things:
- One or
more "stock universe" lists
- Prepare a list of their own "stock universe". But they might have
more than one list, in which case there would be a strategy that
describes how to use each list. For example, one list of speculative
stocks might be traded with just a small portion of the investment
capital, while another list of large-cap blue chip stocks might be used
for longer term and more stable investment returns.
- Have a strategy that describes exactly how an investment would be
made in a stock within the stock universe. Each stock universe would
potentially have a separate strategy to guide the investment.
WHY bother to prepare a "stock universe" list?
Many investors and traders don't prepare a stock universe list. They
simply look across all stocks in the market, and apply a filter (one or
more filters) to produce a list of investment candidates. If you do
work through the process of preparing a list, then you will probably
find the following advantages:
- It will help you to stay focused on the
- It will be easier to prepare a trading/investing plan
to is suitable for a specific stock universe, because the strategy
might be a little different for a different stock universe.
- It will help to avoid distractions. Many
investors/traders are happy to read the latest news and announcements
about their "favourite" stocks. But if we invest in potentially any
stock in the market, then there is too much news to read. By having a
stock universe, it will help us to decide which news to read, and which
news to skip over.
What if I don't prepare a "stock universe" list?
It's quite okay if you don't prepare a "stock universe" list. You can
still search through the whole market for investing/trading candidates.
And you might be distracted by stocks that don't really fit your stock
criteria. That's okay. Some people would say that this is not the
smartest way to operate. But you will probably end up at about the same
HOW to compile your own "stock universe" list:
how do we compile our own "stock universe" list? Here are some
considerations for investing in equity markets around the world. The
"stock universe" might simply be any one of the following:
If focusing only on the Australian market, then the following
considerations might be useful:
- The stocks in a particular large-cap index (eg. in the US market,
perhaps the S&P500 index).
- A selection of mid-cap stocks.
cap stocks - Smaller cap stocks (eg. in the US market, the
stocks in the Russell 2000 index).
specific - The stocks in a particular market sector (eg.
Health Care, or
Technology), or make a conscious decision to ignore the stocks in a
particular market sector (eg. Materials, or Energy sectors).
manual selection of stocks based on market cap - This can
be done using appropriate stock
selection tools (more notes below).
- You might choose to invest (or trade) only in liquid stocks. That is,
the stocks that have enough turn over on the market each day so as to
increase your chances of getting into a position, or exiting one,
quickly and without moving the market. See a
discussion about Stock Liquidity. This topic is also to with Risk and
- The so-called "top 200" stocks - the XJO index
- The so-called "top 500" stocks - the XAO index.
- The stocks in the mid-cap 50 index (XMD).
- The stocks in the Small Ordinaries index
Some considerations to help you decide
When giving some thought to this topic, the following considerations
- Blue chip stocks:
- Many investors think that they would like to invest in blue chips stocks. That is a good aspiration.
there is no clear definition of the term blue chip, and therefore there
is no list of blue chip stocks to work from.
- See the latest definition of the term blue chip at the ASX website, and note that this definition wording has changed a couple of times since the GFC in 2008.
- Any broker or financial advisor that has a list of blue chip stocks is using their own criteria to compile the list.
- In truth, at various stages of the economic cycle, blue chips can disappoint.
- If you are looking for a definitive list of blue chip stocks, then good luck.
- Large cap stocks:
- These tend to have a market capitalisation in the order of $10 billion or more (subject to change).
- These are analysed by the research analysts, and
recommended by the brokers.
- There tend to be many buy/hold/sell recommendations
for these stocks
the 2000+ stocks on the Australian market, only a small number of them
are large cap stocks and watched by the research analysts. The
conclusions and recommendations of the research analysts do influence
the opinions and purchase decisions of many investors. You might choose
to consciously follow the crowd and consider their views, or you might
decide to avoid these stocks.
- The Australian XTL index (S&P/ASX 20)
comprises just 20 large cap stocks.
- Small cap stocks:
- These tend to have a market capitalisation in the order between
about $300 million and about $2 billion (subject to change).
companies that are considered to be small cap stocks, tend not to be
watched by research analysts, nor recommended by lots of brokers. You
might decide to ignore these, or to follow these stocks.
- Small cap stocks tend to be less liquid than the
larger cap stocks. So be careful about the stock liquidity.
- Mid-cap stocks:
- These tend to have a market capitalisation in the order between about $1 billion and $5 billion (subject to change).
category comprises stocks that have a market capitalisation in between
the large cap category and the small cap category.
- These stocks tend to be less well followed by
analysts and brokers. You might like this idea, or not like it.
- Micro cap stocks:
- These tend to have a market capitalisation in the order between
about $50 million and about $300 million (subject to change).
cap stocks have an even smaller market capitalisation than the small
cap stocks, and are often even less liquid than the small cap stocks.
- These stocks tend to have even smaller share price
values, which can be volatile.
- Low share prices ("penny dreadfuls")
share prices of companies (on the Australian market) can vary from as
high as $100+ all the way down to less than 1 cent (ie. to fractions of
a cent). The stocks with a share price of just a few cents or less are often
referred to as the "penny dreadfuls" of the market. The penny dreadfuls do not usually include any blue
chip stocks, so some people avoid them.
is true to say that share prices above about $10 are unlikely to double
or triple in price, whereas share prices of less than a dollar or so
can double in price. You might decide to have one strategy that focuses
on low share prices (these stocks can be riskier), as opposed to
focusing on the higher priced shares.
- The notion of stock liquidity is important for a couple of reasons.
- Hundreds of stocks on the Australian market have very low daily trades, and/or low daily volume or turn-over.
realising it, many investors eventually exclude illiquid stocks from
their stock universe at some stage during the daily or weekly search
- Many investors and traders will filter their
list of investment candidates to exclude the stocks with a very low
level of liquidity.
- See more information about stock liquidity.
How do the above market indexes relate to each other? Is any one of them
included within another? See
Robert's Index Composition handout.
- You might have a view that info-tech stocks are likely to have the
best candidates at the current point in time. So you might choose to
focus on the stocks within the info-tech sector. Likewise, for the
healthcare sector, or one of the other sectors.
investors consider some types of sectors to be "old world" as opposed
to "new world". For instance, the technology sector stocks are
considered to be companies that are more likely to be more valuable in
the long term. This notion is discussed in Nicholas Darvas's book "How
I Made $2,000,000 in the Stock Market".
is one key point to bear in mind about sectors. The sector indexes (eg.
XIJ, XHJ, etc.) are only comprised of stocks from the XJO (S&P/ASX
200) index. If you want to know what other stocks across the market are
considered to be in the same GICS sector, then you will need to look at
a list of stocks grouped by GICS industry group code. See more about the GICS coding system.
- See more information about the Australian market
sectors, including downloadable information sheets.
Stock selection tools
So how do you actually go about compiling a useful stock universe list?
Many investors/traders will maintain a list of their favourite stocks
(their stock universe) as one or more watch lists in their computer
software - either with their online broker, or in their chosen software
package. It is quite alright to have more than one stock universe,
depending on your investing strategy.
The range of available tools includes:
- Search tools available with your online broker.
- Free web-based search tools at various websites.
- Charting and technical analysis software tools - such
Some more tipsHere are a few tips about how to find stocks in a particular category like those described above:
* - The Australian BullCharts charting software is this author's preferred tool, and can perform these searches.
stocks of a particular range in market cap, use your charting software
to do a search* (in BullCharts, one of the 140 supplied scans is in the
"Fundamental" category, to scan by Market Cap).
- For the stocks in a particular sector, view the "Index Composition" section in Security Manager in BullCharts*. (See the screen shot at right)
- For the stocks in a particular GICS industry group, view the "Industry Groups" section in Security Manager in BullCharts*. (See the screen shot at right)
- To find out the liquidity level of various stocks, firstly understand more about the issues to do with liquidity, and then use a tool* to identify the liquid stocks for inclusion in your universe, or the illiquid stocks to exclude.
See the links above right for more