During our market reviews, we often refer to asset allocation. What do we mean when we refer to asset allocation? We are referring to factors that could influence the return on your investment when you invest in certain asset classes. The main asset classes are shares (including preference shares), bonds, cash equivalents and money market vehicles, real estate, commodities, and these days also cryptocurrencies. We invest in all these asset classes, but we avoid direct investments in cryptocurrencies. The share universe can be broken down to a few distinct types of shares, like growth shares, value shares and high dividend paying (income) shares.

We construct clients’ portfolios to give them exposure to different asset classes and distinct types of shares. The goal is to reduce risk, increase growth, or create income depending on a client’s financial goals and mandate. A financial advisor can be key in assisting you to construct a portfolio that will aid you in reaching your financial goals. When an investor decides to buy, or sell stocks, it is particularly important to look at what you currently have in your portfolio. The following are examples of three types of shares and why they should be included, or excluded, from a portfolio.

Value Stocks: How do you know if your chosen stock is a value stock? If the stock’s market price is lower than its book value, or net asset value (NAV), your stock is seen as a value stock. We will say the stock is trading at a discount to its NAV. The discount is often referred to as a “Margin of Safety.” It is like buying something on a sale in a shop. It is more difficult to recognise a stock that is on “sale” than let us say a clothing sale, since there will not be a “For Sale” sign posted at the JSE or LSE. You would need to calculate the discount to NAV when you do your financial analysis on the company to determine the share’s NAV. Typical value stocks are Remgro and Naspers that are trading 10 – 20% below their NAVs.

A value stock is a type of stock that could be profitable for your portfolio. The strategy is built upon the expectation that an event (a catalyst) will unlock the stock’s value. An example is the accommodation industry that was hit hard during the Covid lockdowns. Now that people are free to travel again, we can expect the accommodation industry to recover. When you are buying shares in a company, you become a part-owner of the company. It is important to understand the industry. Do not invest in something that you do not understand. It is considered best practice to examine the make-up of the company, analyse the financial statements, and decide if it is a sound business, regardless of what other investors are saying.

Secular Growth Shares or non-cyclical Growth Shares: A second way to classify a stock is to look for what we consider a secular or non-cyclical stock. Secular stocks must not be confused with cyclical stocks. Secular is a term used to describe a stock’s behaviour over a prolonged period, regardless of other trends occurring within the market over a short term. The beauty is that secular shares are immune to short term volatility. Secular or non-cyclical companies’ primary business normally relates to consumer staples or products that most households consistently use or cannot do without. Medicine and food are good examples. Typical companies are Shoprite, Spar, Pick n Pay and Dis-Chem.

Cyclical Shares: Cyclical stocks are affected by global economic conditions. When the economy is doing well, so do cyclical stocks. When the economy is doing badly, so will the prices of cyclical stocks. An example of cyclical shares would be luxury goods. This is the pattern: (1) The economy is booming, allowing people to have discretionary money to spend on luxury goods. Sales of luxury goods consequently increase, resulting in higher profits and higher share prices. (2) During a recession, there is a decline in employment, and consequently less discretionary money for households. Households then spend less on discretionary goods. The consumer has an option (discretion) to delay the purchase of discretionary items. Consumers can delay the purchase of furniture, clothing, and luxuries like holidays and jewellery. Sales of discretionary goods, like jewellery, drop; profits drop, and so does the price of the stock. Timing is everything when investing in cyclical stocks. Investors need to detect the early signs of whether the industry is picking up or slowing down. Be alert to catalysts that could trigger the change in the stock price and when the catalyst emerges, act quickly. Typical cyclical stocks would be clothing companies (Mr Price), restaurants (Spur), hotels (Sun International), furniture retailers (Lewis), and car retailers (Motus).

BOTTOM LINE: There are more types of shares like growth shares, commodities, and preference shares. Unfortunately, we do not have the space to discuss all of them. Stocks can be bought for specific reasons. It is important to build your portfolio and have a goal in mind for each stock in your portfolio. Each stock in Overberg Asset Management’s model portfolios has been carefully selected to support our clients’ journey beyond wealth. Our investment team works hard to ensure that the right mix of assets and types of shares are allocated for each of our clients. This article is not intended to be financial advice. Please contact one of our consultants for advice.