How to pick shares

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Look at the economy

Use the economic cycle to help choose shares.

Over time, the global economy will grow and shrink. This cycle is natural, and it has taken place throughout history.

When the economy is growing strongly, people are typically optimistic. They often have more money and are happy to spend it. But when times are tough, people tend to tighten their belts. They may forgo luxury treats or the family holiday or hold off buying a new car.

You can keep an eye on this cycle and use its ups and downs to pick which shares you buy at which time.

Defensive shares

You can think of defensive shares as ‘steady-eddies’. They may not grow as quickly during the boom times, but they also haven’t struggled to the same extent in tougher times. That’s because companies with defensive shares sell things or provide services that people need and use, no matter what the economy’s doing.

A great example of a defensive area of the market is pharmaceuticals. Even when the economy isn’t doing so well, people and governments still need to spend money on medicines.

They’re called defensives because they can be a potential line of defence when stock markets are falling. Of course, no company can be completely recession-proof. And defensive companies can still fall in value.

For example, supermarkets are seen as defensive – people need to eat, even during a recession. But you could also switch to a cheaper supermarket or different brands of food and drink.

Tip: Think about the products and services you’d buy even in tougher times – the companies selling them are probably ‘defensives’.

Three things to look for in a good defensive share:

1. The company’s earnings are relatively predictable – it’s a profitable company with good returns.

2. The goods or services that the company sells are always in demand, preferably across a number of different countries.

3. The company pays a healthy dividend to shareholders – paying out profits as a dividend shows that the people who run the company are confident that the company will continue to make profits in future.

Cyclical shares

Cyclical shares typically mirror the health of the economy. Profits and dividends rise during the good times but suffer during slumps.

It’s difficult to judge when the market has hit the bottom. But if you buy at the start of an upturn, you could get in before things heat up.

Bear in mind that not all cyclical shares are hit at the same time. For instance, in a recession, we spend less and retailers feel the effect immediately. Suppliers and distributors then feel the knock-on effect as the shops reduce their orders. However, makers of components and producers of raw materials come into the cycle last.

Tip: Cyclical shares have often performed well when the economy is growing strongly. But during a downturn, defensive shares have tended to do better.

Three things to look for in a good cyclical share:

1. The company has little or no debt.

2. When there are downturns, the company can anticipate or react quickly to them.

3. In the good times, the company doesn’t overexpand.

Major cyclical and defensive sectors

Buy shares in 3 simple steps

Ready to start buying shares? The good news is that it’s much easier than you might think. If you don’t have a share dealing account, you could open one online today in minutes. Then:

1. Log into your account

2. Select the share you want to buy

3. Get a live price and buy, or set a limit

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