Portfolio Management Thoughts

There has been a lot of discussion here lately around two issues that for me fall under portfolio management.

  1. How many stocks to hold
  2. How large to let any one position run

For me, the answers are related. Having 30% or 50% of your portfolio in one position is very akin to having a portfolio of just 2 or 3 stocks. You may have 50 other stocks after “the big one,” but they won’t save your ship if anything happens to the big position.

So why not hold just 2 or 3 stocks? For me a concentrated portfolio is about being aggressive, and a balanced portfolio is about being humble. I’m aggressive enough to not fully diversify – to focus on the companies I really think are the best, regardless of industry. But I’m humble enough to know I will never bat 1.000.

In my opinion it doesn’t matter whether you have $10,000 or $10,000,000…you still need to come up with several good companies to buy stock in. Then you can afford for Square to settle in for a while as Shopify takes off, or for Pure Storage to finish its little growth spurt just as Wix starts its own. (Just examples.) Because even with the best companies in the world, we never know exactly when the prices will move, but it’s unlikely they’ll all go up proportionally at the same time. That, to me, is why it makes sense to spread out allocations among several companies. Heck, even if you just have 8 good companies to buy stock in with 10% to 15% in each, that is SOOOOOOOOOOOOOOOOOOO much better than one company at 30%, 40%, or 50% of your entire portfolio.

Just my thoughts.

Bear

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"For me, the answers are related. Having 30% or 50% of your portfolio in one position is very akin to having a portfolio of just 2 or 3 stocks. You may have 50 other stocks after “the big one,” but they won’t save your ship if anything happens to the big position.

So why not hold just 2 or 3 stocks? For me a concentrated portfolio is about being aggressive, and a balanced portfolio is about being humble. I’m aggressive enough to not fully diversify – to focus on the companies I really think are the best, regardless of industry. But I’m humble enough to know I will never bat 1.000.

In my opinion it doesn’t matter whether you have $10,000 or $10,000,000…you still need to come up with several good companies to buy stock in."

If anyone of us had perfect foresight it would make sense to invest in the “best” company. Since we don’t, spreading our chips over a few more companies allows us the chance that some of these good companies may become GREAT ones.

Rob

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Bear,

Your post echoes strongly of the research papers I read advocating 10 or so stocks… and not less than 4… no more than 25% in any one position. I didn’t keep links and references to all the papers I read but your post is very much along the same thought process they presented.

They also talked about when you have a large number of stocks… say 100 at 1% each… that’s great diversification in that one stock tanking won’t tank your portfolio… but it’s also true that one stock doubling won’t appreciably help your portfolio a bunch either… and it’s hard to pick 100 winners… easier to pick up a smaller number of very high confidence.

Agree completely.

Mark

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It’s all about what the late Marty Whitman called the risk of ‘a permanent impairment of capital’.

in that example, one only would diversify 1/3 or 1/2 of its portfolio while betting the other 2/3 or half on one or two stocks.

so you still can soften the blow if that one or two come at you with a negative surprise.

Spreading over ~10 stocks can help you if the correlation between them are low but that may not be the case for many of the stocks talked about here. There is a tendency to separate and go up up and up or go down down and down. You just have to sit on the right side of the fence.

tj

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There has been a lot of discussion here lately around two issues…

There was a third issue Prodigal addressed: How large to let any one sector run.

If most of your stocks are SaaS companies it’s like owning a bunch of sunglass
companies when the weather has been all sunshine the last few years.

Having 50% or 70% of your portfolio in one niche sector is akin to having a portfolio
of just 2 or 3 stocks. The rest won’t save you when the rainy season gets here, especially
if it’s a prolonged monsoon.

Been there.

Ears

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The pros usually say 8 to 15 stocks is an appropriate number for an individual investor to keep up with news events.

Keeping each holding below 20% of assets is a reasonable rule.

A portfolio of handful of well chosen stocks can suit. But does that mean million dollar positions in those stocks? Ouch!! Your ability to sell in a downturn can be limited.

Most prefer a more diversified portfolio.

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When the sun goes down and the monsoon sirens begin to sound you can always sell your sunglass holdings and buy umbrella ?? holdings.

Tinker

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What Bear wrote seems so obvious to me that it’s odd that we have to keep repeating it. Okay:

What’s wrong with having 100 stocks? Nothing if you are willing to accept results that are about the market averages. Look, your possibilities of picking 10 stocks that can rise an average of 40% or 50% in six months are do-able! There are lots of us who have done it this year and last. The possibility of picking 50 or 100 stocks that can average up 40% or 50% in six months are roughly zero.

Why not? Because you can’t know anything about 100 stocks. If you see the ticker you may not even remember the name of the company or what it does. You can’t remember what field it’s in. You can’t possibly read even half of the earnings reports, or know what they’re about , or remember what the issues are. All you’ve got is a market average, hopefully with a slight positive bias.

What’s wrong with having 3 stocks at 30% to 40% of your portfolio each? You can keep track of earnings really well, but it’s a little like playing Russian Roulette. One company that hits a snag, a new competitor, a recall, a product snag, a fraud, and you can lose 30% or 40% of your portfolio overnight. Are you good enough that none of your stocks ever crashes? I’m not. I just lost 50% with Nektar, for example. In the two weeks since it dropped from almost $90 to $52 in one day, my portfolio as a whole rose from up 48% to up 60%, because Nektar was just one of 10 stocks, and enough of the others were up big. But it Nektar had been a 40% position, wow! Remember, if you drop 50%, getting back to where you were isn’t rising 50%, it’s rising 100%, it’s doubling! If you drop 75%, getting back to where you were isn’t rising 75%, it’s rising 300%, it’s quadrupling. You don’t want to put all your eggs in that few baskets!!

Best,

Saul

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Having 50% or 70% of your portfolio in one niche sector is akin to having a portfolio of just 2 or 3 stocks. The rest won’t save you when the rainy season gets here, especially if it’s a prolonged monsoon.

Peter Lynch called this Diworsification: https://www.investopedia.com/terms/d/diworsification.asp

Diworsification occurs from investing in too many assets with similar correlations that add unnecessary risk to a portfolio without the benefit of higher returns… A diversification strategy involves an accumulation of assets with varying correlations, which reduces risk and can increase potential returns by minimizing the negative effect of any one asset on portfolio performance.

But there’s the rub. Spreading out one’s portfolio to cover enough independent sectors so that a downfall in one sector doesn’t affect the others typically means that you’ll have enough sectors so that it’s more likely that one or two will indeed decline. And so you end up with commodities, international, technology, energy, consumer, manufacturing, and other sectors and you’d be better off just following Buffett and throwing it all into an S&P500 index fund and enjoying your life for 30 years without much worry before you want to retire.

But, that’s not good enough for us on this board. We want to beat the S&P 500, and we’re willing to do the homework achieving that entails. That does mean taking on additional sector risk, but if we’re smart about it and remain agile enough (Saul’s agility is amazing), we can avoid most of the pitfalls of sector concentration while gaining most of the rewards.

However, it remains important that we realize that the stocks discussed on this board typically are heavily concentrated in just a few sectors. When I look at all the database and data analytic companies discussed here, it’s clear there’s a very narrow sector focus for much of the investments. So we do need to monitor things closely. Yeah, it’s not like data is going to go out of style anytime soon (unlike, say, a Sketchers), but it’s also not like the industry won’t see upheavals or even that in a general downturn companies won’t scale back data analytics as an early cost-cutting measure.

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“But does that mean million dollar positions in those stocks? Ouch!! Your ability to sell in a downturn can be limited”

Yes, good point. It struck me like a slap in the forehead when I realized that someone on the other end has got to buy the stock you are selling. Might not happen right away.

If most of your stocks are SaaS companies it’s like owning a bunch of sunglass
companies when the weather has been all sunshine the last few years.

Let’s see. Now someone is going to tell me that Shopify (ecommerce), Twilio (communications), Alteryx (making data analysis easy), and Nutanix (whatever odd thing they do) are all in the same field because they all lease software instead of selling it outright. Really? Oh my, I should be scared!

Saul

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Let’s see. Now someone is going to tell me that Shopify (ecommerce), Twilio (communications), Alteryx (making data analysis easy), and Nutanix (whatever odd thing they do) are all in the same field because they all lease software instead of selling it outright. Really? Oh my, I should be scared!

Saul

Very good point, Saul. Just because companies might have similar SaaS business models does not necessarily mean they are heavily correlated.

Software and data are simply far, far more large a part of the 2018 economy than they ever have been at a prior point in history. Computing power is not going away. The Internet is not going away. Horses and buggies aren’t making a comeback.

Lumping all companies together because of their business model with recurring revenues would be a mistake of an oversimplification.

volfan84
Long SHOP, AYX, & NTNX; no Twilio position

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It’s all about what the late Marty Whitman called the risk of ‘a permanent impairment of capital’. – strelna

A couple thoughts:

  1. It appears that many corporate executives are heavily loaded in one company. Yes, they are aware of more details than the “common folk”, but they can also tend to be too focused on the details. If they have “enough” money, is it that big a deal to be concentrated?

  2. Just hypothetical, I assure you, but suppose for a minute you had $1 Billion dollars. If you had 1/3 of it in just one company and you lost half of that, would it be that big a deal? It wouldn’t be to me, I believe, as long as I was following “my methods”.

Now scale #2 down to $100 million, then $10 million and perhaps less. If you can live just fine with $1 million, is it that big a deal if you have a few million in a concentrated portfolio in just a few solid companies?

IMO, no…it’s just fine.

  1. What if you’re building your retirement fund, you’re 30 or 40 and you’re concentrated? If you lose a big chunk, is it that big a deal? Not in my experience. You can make it back pretty quickly, assuming you’re not facing a decade long bad market. And that hasn’t happened in the 52 years I’ve been investing. I suppose it could happen though but I suspect there would still be ways to adapt. There always seems to be “a way” if you’re creative.

Rob
Rule Breaker / Market Pass Home Fool & STMP/MTH Maintenance Coverage Fool
He is no fool who gives what he cannot keep to gain what he cannot lose.

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@saul and earslookin
If most of your stocks are SaaS companies it’s like owning a bunch of sunglass
companies when the weather has been all sunshine the last few years.

Let’s see. Now someone is going to tell me that Shopify (ecommerce), Twilio (communications), Alteryx (making data analysis easy), and Nutanix (whatever odd thing they do) are all in the same field because they all lease software instead of selling it outright. Really? Oh my, I should be scared!

Two of my favorite posters can’t disagree! It shatters my worldview :slight_smile: Jokes aside I think you both have important points. NTNX, PVTL, MDB, PSTG are all dependent on this incredible shift of computing to the cloud that we are seeing. TWLO, SHOP, OKTA, are a bit of a secondary market where companies have decided that someone else can provide key infrastructure better than they can do it themselves. Lets not forget that not too long ago verticales and conglomerates were the business models de mode. The idea was to bring everything under one umbrella and control everything. I also think that ears’ point about the SaaS business model is worth keeping in mind. Personally I’m not 100% sure we have seen the full life cycle of enough SaaS companies to know how this plays out. Salesforce is the oldest public SaaS only company which bodes well for us since it is such a super start but lets not forget CRM is only like 18 years old. We very well could see some huge implosion and people go back to thinking they are better off keeping everything in house. I highly doubt it though. Personally I have been trying to make my portfolio a little less reliant on cloud infrastructure (NTNX, PVTL, MDB, PSTG, NVIDA, ANET) but I haven’t been very successful because that desire wars with my strong belief that we are in a paradigm shift toward companies with much stronger digital presences. I just don’t think there is enough expertise out there for each company to develop and maintain their own IT services.

Thanks for the good discussion to all though. This stuff is important to keep in mind especially when we are making money hand over fist and are all tempted to take on more risk.

best,
Ethan

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I know it’s not a popular choice on this board but the way I solved this is
Half my investments (my wife) are in index funds
My accounts are in single growth stocks.
If I crash and burn They’ll be ok.
If things keep going like they are (and I expect they will) we will all be sitting pretty

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In Response to Rob, who I respect as a long time fool.
I personally would be ok with a large market downturn but not so comfortable with having 1 of 3 stocks absolutely tank (50%) or more.
Hence I stick to around 8 single stocks. That being said, due to a threefold increase in shop it has become over 30% of my holdings
I’ve trimmed before but have no plans to trim anymore
Otherwise nobody would have held AAPL MSFT or a SBUX type killer over a decade or two

I just don’t think there is enough expertise out there for each company to develop and maintain their own IT services.

good point
Companies should focus on their core business

I do the same as MusiCali. My personal retirement accounts are in individual stocks, my wife’s are in index funds. Partly for safety, partly because I couldn’t live with myself if I lost my wife’s money in stocks, at least until we’ve got enough to be comfortable in retirement and I can be more confident in my stock picking.

I do agree with Rob’s points. The amount of funds in a portfolio and one’s risk tolerance (and dependence on those funds) must come into play. If you have only $10,000, I don’t think it makes sense to even diversify into 10 stocks. Especially if you intend to trim whenever a stock reaches 20% or whatever. Even a 10 bagger won’t be enough to materially affect personal wealth with a 1% position, particularly if it is trimmed along the way. Imagine you bought NFLX and 9 other “average” stocks in 2008 with $1000 positions each. Letting NFLX run would be a lot better than trimming whenever it got to 20% of the portfolio, I suspect by tens of thousands or dollars if not more. AAPL over the past 20 years might be an even greater difference.

If you’re relatively young and have a lot of earning potential ahead, consider what percentage of your target portfolio a position might be. I’d rather just add new funds to other stocks to bring down the position size.

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“I know it’s not a popular choice on this board but the way I solved this is
Half my investments (my wife) are in index funds
My accounts are in single growth stocks.
If I crash and burn They’ll be ok.
If things keep going like they are (and I expect they will) we will all be sitting pretty”

Here’s the thing. Popular be damned. You do what you think is best for you and yours and live with the results. I’ll let you in on a little secret. If you do what you think is popular, no one on the board or any other is going to pay your bills if things go south. Great input on this board and NPI but in the end you MUST do what you think is best for you.

Rob

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