We've all heard the old adage that 50% of a stock's price movement can be attributed to the group that it's in.
In fact, studies have shown that just getting into an average stock in a strong industry is likely to outperform a great stock in a poor industry.
Of course, this does not mean that you can just pick any stock in a top group and expect to make money. But, it does underscore the importance of sticking with the best industries.
If your last losing stock was in a poorly performing industry, the odds of success were against you the entire time.
But identifying the best stocks in the best industries is easy to do. And the Zacks Industry Rank is the ideal way to do that so you can put the odds of success in your favor on your very next trade.
Zacks Industry Rank
As you know, since 1988, the Zacks #1 Rank stocks have generated an average annual return of over 26% per year. That's nearly 3 times the S&P 500. And it's beaten the market in 23 of the last 26 years.
That's because the Zacks Rank is based on the most powerful force impacting stock prices, which is earnings estimate revisions.
The Zacks Rank is also one of the best ways to rank industries. And this is done with the Zacks Industry Rank. After all, since an industry is nothing more than a group of stocks in a similar business, this is the perfect way to size up an industry.
The Zacks Industry Rank is determined by calculating the average Zacks Rank for all of the stocks in the industry and then assigning an ordinal rank to it. For example, an industry with an average Zacks Rank of 1.6 is better than an industry with an average Zacks Rank of 2.3. So the industry with the better average Zacks Rank would get a better Zacks Industry Rank.
Zacks classifies all stocks into 1 of 265 expanded (aka 'X') Industries. The average Zacks Rank is calculated for every industry every day. So, if an industry has the best average Zacks Rank, it would be considered the top industry (1 out of 265), which would place it in the top 1% of Zacks Rank Industries.
The top 132 Zacks Ranked industries would be in the top 50% of industries, whereas the bottom 133 Zacks Ranked Industries would be in the bottom 50% of industries.
If an industry had a poor average Zacks Rank, it might be ranked 220th out of 265 industries, thus placing it in the bottom 17% of Zacks Rank Industries.
Putting the Zacks Industry Rank to the Test
To further illustrate the importance of picking stocks in the best industries, and how the Zacks Industry Rank is one of the best ways to do this, take a look at the test results and chart below.
We put our X industries (all 265 of them) into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).
Over the last 10 years, using a one week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. The top blue line is the performance of the top 50% of Zacks Ranked Industries. The orange line below is the performance for the bottom 50% of Zacks Ranked Industries. The maroon line is the S&P 500.
Keep in mind that even the worst industries had some Zacks Rank #1s in them. And even the best industries had some Zacks Rank #5s in them. That goes to show the power of simply being in the best group.
The next chart shows what would happen if only the Zacks Rank #1s were applied to the top Zacks Ranked Industries.
The results were even better, adding to the already impressive returns by an additional factor of more than 1.5x the top industry. The top orange line is the performance of the top 50% of Zacks Ranked Industries with just the Zacks Rank #1s. The blue line below is the performance for the top 50% of Zacks Ranked Industries with all Zacks Ranks included. Once again, the maroon line is the S&P.
It's clear that selecting the best stocks in the best groups can give your stock picking a decided advantage, increasing your portfolio's returns like never before.
Using the Zacks Industry Rank
Once again, the Zacks Industry Rank is calculated by averaging the Zacks Rank for all stocks within a specific industry. The industry with the lowest average Zacks Rank will be considered the top Zacks Ranked Industry (1 out of 265) while the industry with the highest average Zacks Rank will be ranked at the bottom of the Zacks Ranked Industries.
Remember, the Zacks Rank is a score of 1 thru 5 with a Zacks Rank #1 (Strong Buy) being the best, and a Zacks Rank #5 (Strong Sell) being the worst.
If there were 10 stocks in an industry and five had a Zacks Rank #1, and the other five a Zacks Rank #2, the average Zacks Rank would be 1.5. That industry would receive a top Zacks Industry Rank.
An industry that had five stocks with a Zacks Rank #4 (Sell), and the other five a Zacks Rank #5 (Strong Sell), would have an average Zacks Rank of 4.5. That industry would receive a low Zacks Industry Rank. Since you always want a diversified portfolio, don't select all of your stocks from the top Zacks Ranked Industry. You should populate your portfolio with stocks from groups in the top 50% of Zacks Rank Industries (top 133 industries).
5 Stocks from 5 Top Zacks Rank Industries
Below are 5 stocks within 5 of the top Zacks Ranked Industries.
I also included some of my other personal favorite stock picking items, including: 'Increasing Net Margins', 'increasing ROE', and a 'Low Price to Sales Ratio'.
• Zacks Rank equal to 1
• Top 50% of Zacks Ranked Industries
• Price to Sales less than or equal to 1
• ROE (recent) greater than ROE (from 1 Quarter ago)
• Net Margin (recent) greater than Net Margin (from 1 Quarter ago)
(ARLP - Free Report) Alliance Resource Partners
(CZZ - Free Report) Cosan Ltd.
(LUK - Free Report) Leucadia National
(PHM - Free Report) PulteGroup
(XPO - Free Report) XPO Logistics
We said it before, but it's worth saying it again: 50% of a stock's price movement can be attributed to the group that it's in. So it's of the utmost importance to make sure your stocks are within the top industries -- specifically the top Zacks Ranked industries.
If you find yourself considering a stock that happens to be in one of the bottom 50% of Zacks Ranked Industries, move on. Sure, it may still go up, in spite of the drag the low industry rank has placed on it. But, why put yourself in a position where the odds are against you? And if you get in, against your better judgment, and it does go down, you'll be wondering why you ever did that in the first place. Instead, put the odds of success in your favor.
Remember, a top Zacks Industry Rank means more stocks within that group are receiving upward earnings estimate revisions. That means something positive is happening to that group. Not just that stock, but for the bulk of those stocks within that industry's business. If it has a poor Industry Rank, that means more companies within that industry are receiving downward earnings estimate revisions. In other words, conditions are tough for that industry's business right now, causing the analysts following that group to lower their estimates.
Simply put, your most profitable stocks will be those with upward earnings estimate revisions in the industries enjoying the same.
And there's no better way to increase your odds of success than by combining the Zacks Rank and the Zacks Industry together.
Sign up now for your free trial to the Research Wizard and start using the Zacks Industry Rank today.
Click here for your free trial to the Research Wizard.
Want more articles from this author? Scroll up to the top of this article and click the FOLLOW AUTHOR button to get an email each time a new article is published.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.