Now that you have identified yourself as an Individual Investor, who is not here to make a quick buck, or a lakh but build a portfolio over time, a lot of questions remains to be answered. What to buy, how much to buy and how many of them should you buy!
There are 5000 plus listed companies in the stock market and you certainly cant buy them all. There are some guys who are happy owning less than Ten stocks while some would be willing to buy a Hundred scrips in order to diversify. There are numerous theories on diversification, most recently by Samir Arora when he gave some backtested data proving how a number of companies will do well every year and if you buy close to 25-30 stocks which do reasonably well, you would do great. Then there are guys like Ramdev Agarwal who prefer concentrated portfolio. However, this definition of concentrated and diversification is generally blurred as for me holding five stocks is diversification while you’d say a thirty stock portfolio is concentrated. My point is to not get into this debate at all. Let me elaborate.
As an Individual Investor, you are at liberty to own any stock, in any quantity, for any length of time( assuming it doesn’t blow up). My suggestion is since you’re trying to build your own portfolio, don’t be too structured in the sense falling pray to a false theory which might work only for institutions trying to justify their commissions to their High Net worth clients. The biggest disadvantage they have is that they can’t own the less favoured for it might cost them their jobs sooner than it comes back in favour of the markets.
Once I have a stock in hand, first of all I want to quickly find a reason to not buy it. Stock picking is the art of negation. I don’t own a single chemical stock because as a chemical engineer, nobody in my entire batch wanted to work in any of these companies. Similarly, nobody in my college wanted to work for Infosys or TCS so I’d not own their shares. This allows me to slowly build my circle of competence meaning I can narrow down sectors I can develop greater understanding of. Ofcourse this makes me lose on the great bull runs in certain sectors but this is life, you only get as much. I can leisurely read balance sheets and annual reports and other information pertaining to my type of companies while avoiding everything else happening in the markets. This means I’m least bothered by the noise and know exactly what to buy when I’ve money.
Once I have identified the sectors, then comes the question of individual stock picking. My idea to buy a stock is that it should: 1. Generate sustainable profits over time
2. Have an easy to understand business model
3. If I am not using the product, I atleast know someone who is.
4. The opportunity is visibly large in my idea of how India will be in 2025 and beyond.
5. Capital light i.e. generates enough cash to fund expansion without diluting equity and at the same time requires little to no capex- to expand. 6. There must be little to no debt on its balance sheet. A man who owes nothing can’t go broke. This works well for large companies as well. 7. Dividends must be liberal so that I can hold out without worrying too much about price appreciation in the short term.
Coming to diversification, I don’t want to own more than ten to fifteen stocks for one simple reason. If I like a company, I want to atleast buy significant amount of shares so that if I’m right and the stock goes up, it must move the needle for my networth. This is also one reason why I don’t buy IPOs. If you buy Reliance at 800 and it goes up to 2000, you make 150%. However, what’s more important is the absolute sum of money which you’ve made. If you only bought 10/20/50 shares, you end up making 8-16-40k in the strongest rally in the biggest stock in India. An extremely costly miss. You don’t create wealth by betting less on your biggest ideas. You make it big by loading up the truck once you’ve done the hard work. If your idea after doing so much research and so much hardwork, buying shares in panic and holding them ends up making 50k for you, you are better off putting money in an FD. Since capital is limited and you want to put significant sums to your big ideas, you can’t buy thirty stocks blocking your capital at the wrong time.
Also, as an individual, you simply can’t keep track of more than ten fifteen stocks at max working through your day job and family responsibilities. Remember, stocks are not piece of papers but real minority stakes in real companies. Imagine if you’re an owner of a company, will it be even possible to attend board meetings of fifteen companies which you supposedly own. In case you are highly diversified like a fund manager, and own north of twenty companies, try writing names of all companies which you own, their last traded price the amount of money you’ve put in and one major product they make. You’ll have your answer by the end of this exercise as to how many stocks you can own. Don’t own one bit more than you can track in your head easily.
One last point. I have one word for Modern Portfolio Theory. Junk. This whole idea of beta as risk and correlated returns is designed to intellectualise high fees charged by both MBA schools and fund managers. If you can own one good company, you’ll do well in life if it turns out to be good. There are enough retailers who have held on to their Reliance shares since late 1990s which are now worth lakhs and lakhs against the initial investment of next to nothing. Don’t limit yourself from owning more of a great company specially when it’s trading dirt cheap just because hypothetically it’s more than 10% of your portfolio. Like I have said earlier, the biggest mistake is made after doing the hard work and buying Ten shares of Reliance at 800!
Life is all about Compounding! 