It is better to focus on a much smaller list of companies, but go significantly further in understanding them. An investor may actually only need to know a few hundred companies and stocks to get through their entire investing life. The key, then, is for the investor to find a balance between knowing just enough to let good ideas come in through the door without being so distracted and spread thin that they risk "paralysis by analysis."
If the financial markets sometimes behave like a giant circus, then investors ought to consider a three-ring approach. This approach will help investors sort out their priorities, allocate their time most effectively and balance out the need to keep a broad perspective with the equal need to maintain focus and attain a deep working knowledge.
(Learn how to create a watchlist at Investopedia to start tracking your favorite stocks and ETFs.)
Create Circles of Competence
It is important for investors to create circles of competence — areas where they have above-average knowledge. This competence can come from firsthand industry experience, or it can be a product of years of careful study and attention.
The reality, though, is that it is impossible to be proficient (let alone an expert) in all areas, so investors are well-advised to focus their attention on becoming proficient in a few sectors and perhaps finding advisors or analysts that they can trust to fill in the gaps.
Research Vertically and Horizontally
It is important for an investor to make the most of the time available for research, and one of the best ways to do this is to research vertically (suppliers and customers) and horizontally (competitors).
To properly understand a company, it is important to have more than just a cursory knowledge of its supply chain, customers and competitors. So why waste that knowledge and research? One of the best ways to make the most of that time is to cast the net just a little wider, spend a little extra time and add a few other companies to the research list.
If an investor is researching Coca-Cola (KO), it makes complete sense to also research PepsiCo (PEP). Likewise, researching Pfizer (PFE) could lever that knowledge with additional names like Merck (MRK) or Johnson & Johnson (JNJ).
Three Rings of Possible Investments to Follow
One of the best ways to control the chaos that can stem from ongoing financial research is to separate investment candidates into three distinct lists.
Closely Followed Stocks
The most exclusive list should be the "closely followed" list. These are stocks that the investor knows well and monitors frequently. It's not necessary to know these companies so well that an investor can rattle off the name of the vice president of marketing, but a strong familiarity with the company's products, markets, competition and recent financial performance is the goal. It is not necessary to follow these stocks on a day-by-day basis, but investors should probably try to aim for at least a monthly update of current news and developments.
Casually Followed Stocks
The second list is "casually followed." These are stocks where the investor will know the company pretty well, but will only gather updates a few times per year — most likely in time with the company's quarterly reporting cycle. Having a good working knowledge already in hand, an investor can easily move these stocks to the "closely followed" list with just an hour or two of extra work.
For the most part, a stock on the casually followed list should be a good company with a troublesome valuation or a potential turnaround situation where the investor needs to see signs of real progress before "promoting" the idea to a more closely followed list.
Barely Followed Stocks
The outer ring will be made up of companies that are effectively barely followed. An investor may recall the name of a company and its industry or products (at least in broad strokes), but little else. In many cases, this will be a list of companies that were once more interesting, but have fallen off the radar for reasons of poor execution, unattractive valuation and so on.
Stocks don't typically start off on this list, but there was once something about them that was worth investigating further (perhaps they compete in an interesting industry). They are worth re-examining once or twice a year to see if their situations have improved.
Perhaps some investors will find that they need a fourth list — a list of names that are looked at once or twice and discarded as candidates, but whose information is kept for the sake of thorough record keeping.
A watchlist is basically what it sounds like — a list of stocks that an investor watches with an eye toward taking advantage of if prices fall enough to create an interesting undervalued situation. This takes the "closely followed" list a step further. These are names that an investor would be prepared to buy and own at the right price or with the right catalyst (a sign that growth has reignited, for instance).
Here, too, discipline and focus are keys to making the most of this tool. A watchlist of 200 stocks, for instance, is likely to be too broad for almost any investor to monitor or maintain. Investors should refresh this list at least a couple of times per month. After all, this is generally supposed to be a list of names that an investor is simply waiting to get cheap enough to buy.
Set Aside Time for Research
The last step may actually be the most fundamental to the entire process. A disciplined investor needs a disciplined process. Set aside time every day (or week) to do the requisite work — both researching new ideas and keeping up with developments in those names on the watchlist.
It is also invaluable to establish a flow chart for the research approach. Investors can use this like a checklist to make sure they follow the necessary steps and take a methodical and consistent approach to their research.
The Bottom Line
Keeping tabs on the entire universe of potential investments out there is an extremely daunting task. It is easy to get bogged down or feel overwhelmed to a point where giving up seems like the most attractive move. Above all, consistency and diligence are paramount, but organization can help make an insurmountable task look like a series of manageable routines.
In the case of following the market, it is best for investors to drop the notion that they can follow everything. Individual investors are not hedge fund managers with multi-million-dollar research budgets and clients demanding absolute peak performance. As most people have to fit their investment research around work, family life and many other important demands, it makes sense to create interlocking rings of expertise and knowledge. An investor should focus intently on the best companies he or she can find, and then sort out the rest as time allows.