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Zacks Sector Rank: Improve Your Stock Picking Success

We've all heard the old adage that 50% of a stock's price movement can be attributed to the group it's in.

In fact, studies have shown that just getting into an average stock in a strong sector is likely to outperform a great stock in a poor sector.

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 ones.

If your last losing stock was in a poorly performing sector, the odds of success were against you the entire time.

But identifying the best stocks in the best groups is easy to do. And the Zacks Sector Rank is a great top down method to do that so you can put the odds of success in your favor on your very next trade.

Zacks Sector Rank

As you know, since 1988, the Zacks #1 Rank stocks have generated an average annual return of over 25% per year. That's more than 2 times the S&P 500. And it has beaten the market in 24 of the last 29 years.Learn more about the Zacks Rank.

 

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That's because the Zacks Rank is based on the most powerful force impacting stocks prices which is earnings estimate revisions.

The Zacks Rank is also one of the best ways to rank sectors. And this is done with the Zacks Sector Rank. After all, since a sector is nothing more than a group of stocks in a similar business, this is the perfect way to size up a sector.

The Zacks Sector Rank is determined by calculating the average Zacks Rank for all of the stocks in the sector and then assigning an ordinal rank to it. For example, a sector with an average Zacks Rank of 1.6 is better than a sector with an average Zacks Rank of 2.3. So the sector with the better average Zacks Rank would get a better Zacks Sector Rank.

Zacks classifies all stocks into one of 16 sectors. The average Zacks Rank is calculated for every sector every day. So, if a sector has the best average Zacks Rank, it would be considered the top sector (1 out of 16), which would place it in the top 1% of Zacks Rank Sectors.

The top 8 Zacks Ranked Sectors would be in the top 50% of sectors, whereas the bottom 8 Zacks Ranked Sectors would be in the bottom 50% of sectors.

If a sector had a poor average Zacks Rank, it might be, for example, ranked 15th out of 16 sectors, thus placing it in the bottom 6% of Zacks Rank Sectors.

Putting the Zacks Sector Rank to the Test

To further illustrate the importance of picking stocks in the best sectors, and how the Zacks Sector Rank is one of the best ways to do this, take a look at the test results and chart below.

We put our Sectors (all 16 of them) into two groups: the top half (i.e., sectors with the best average Zacks Rank) and the bottom half (the sectors with the worst average Zacks Rank).

Over the last 10 years, using a one week rebalance, the top half beat the bottom half by more than twice as much. The top blue line is the performance of the top 50% of Zacks Ranked Sectors. The orange line is the performance for the bottom 50% of Zacks Ranked Sectors. And the maroon line is the S&P 500.

Best Worst Sector

Keep in mind that even the worst sectors had some Zacks Rank #1's in them. And even the best sectors had some Zacks Rank #5's 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 Sectors.

The results were even better, adding to the already impressive returns by an additional factor of more than 5X. The top green line is the performance of the top 50% of Zacks Ranked Sectors with just the Zacks Rank #1's. The blue line below is the performance for the top 50% of Zacks Ranked Sectors 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.

Best Sector

Using the Zacks Sector Rank

Once again, the Zacks Sector Rank is calculated by averaging the Zacks Rank for all stocks within a specific sector. The sector with the lowest (best) average Zacks Rank will be considered the top Zacks Ranked Sector (1 out of 16) while the sector with the highest (worst) average Zacks Rank will be ranked at the bottom of the Zacks Ranked Sectors (16 out of 16).

 

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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 Sector and five had a Zacks Rank #1, and the other five a Zacks Rank #2, the average Zacks Rank would be 1.5. That sector would receive a top Zacks Sector Rank.

A sector 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 sector would receive a low Zacks Sector Rank.

Since you always want a diversified portfolio, don't select all of your stocks from just one top Zacks Ranked Sector. You should populate your portfolio with stocks from several groups in the top 50% of Zacks Rank Sectors (top 8 sectors).

And then consider drilling down even further to the top 50% of Zacks Ranked Industries within those sectors for even more outperformance. Learn more about the Zacks Industry Rank.

Summary

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 sectors, and specifically the top Zacks Ranked Sectors.

"Your most profitable stocks will be found in the top Zacks Ranked Sectors and Industries. The more stocks you have from the top groups, the better."

If you find yourself considering a stock that happens to be in one of the bottom 50% of Zacks Ranked Sectors, move on. Sure, it may still go up, in spite of the drag the low sector 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 Sector 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 sector's business. If it has a poor Sector Rank, that means more companies within that sector are receiving downward earnings estimate revisions. In other words, conditions are tough for that sector'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 sectors enjoying the same.

And there's no better way to increase your odds of success than by combining the Zacks Rank and the Zacks Sector Rank together.

Additional Resources:

Zacks Rank Education- Learn about the Zacks Rank

Zacks Industry Rank Education- Learn about the Zacks Industry Rank

Zacks Style Scores Education- Learn about the Zacks Style Scores