The Right Number of Stocks for Your Portfolio

In this issue:
» Will aggressive marketing campaign help e-com firms in the long run?
» Positive macro data unlikely be reflected in earnings soon
» A round up on markets
» ....and more!

00:00

A gentleman I know once owned as many as 60-70 stocks in his portfolio. At first, I was shocked. I wondered how someone could handle so many stocks. And he wasn't even a full-time investor.

I eventually came to understand how this man had accumulated so many stocks. His 'action itch' prompted him to seek new investment ideas all the time. As a result, he was acting on almost every stock idea that came his way. But he had little clue about those stocks and their underlying businesses. So, his level of conviction was poor.

He would invest small amounts in each stock...sell off his winners prematurely...and the losers run, as he was unwilling to sell them at a loss. I don't know his actual returns, but seeing his haphazard investing strategy, my guess is he did worse than the benchmark Indian indices.

I know another gentleman, an astute investor, who follows a sharply contrasting approach. His top four stock picks account for over 80% of his entire stock portfolio. Doesn't that sound highly risky? Not necessarily. He follows a highly disciplined approach and invests only in stocks in which he has supreme conviction.

So here are two very different investors...two approaches that are poles apart.

What do they tell us about portfolio diversification? What is the right number of stocks that an investor should have? Should you have four stocks...30...or as many as 60 stocks in your portfolio?

Let's consider what some of the world's greatest investors did...

Peter Lynch, the famous fund manager at Magellan Fund, is known for achieving the best 20-year average return compared to any other mutual fund manager on record. But did you know that when he retired, his fund had over 1,500 stock positions?

As of 30 June 2015, Warren Buffett's Berkshire Hathaway held close to 50 stocks. But guess what, his top five holdings accounted for about two-thirds of the total stock portfolio worth over US$107 billion.

What does all this mean? Does the search for the 'right number' get more and more confusing?

Let me tell you that there cannot be a one-size-fits-all answer for this. Each investor has to find what works best for him. In your quest for the ideal portfolio diversification, keep these two guiding principles in mind...

1. The real risk is not knowing

You could have a diversified portfolio and have a feeling that your portfolio is safe. But you could still lose money. If you do not have a sound stock selection process, if you have no clue about the businesses that you have bought...the risks that underlie those businesses...then you are certainly treading a risky path. So, understanding where you are putting your money is a key investing principle.


2. Follow their principles, not their actions

If Buffett has about 50 stocks in his portfolio, that doesn't mean it's the right number of stocks for you. Despite the fact that he has nearly 50 stocks, he has a highly concentrated portfolio. The top five stocks account for the bulk of the total portfolio value. So, is high concentration the right answer for you?

If you are a full-time investor...if you have a deep understanding of businesses...if you have your own independent views on stocks...if you have high conviction about your stock ideas...if you have high risk appetite...then having a concentrated portfolio may make sense for you.

But if you are an amateur investor with moderate risk appetite, then having a well-diversified portfolio is the right way to go.

Investment guru Joel Greenblatt has said that owning about 16 stocks eliminates about 93% of the non-market risk. Again, one-size-fits-all portfolios don't exist. But we agree that this is a reasonable ballpark figure for the average serious long-term investor.

But this number is not the Holy Grail. A few more or less might work better for you.

In your view, what is the right number of stocks for your portfolio? What works best for you-concentrated or diversified portfolio? Let us know your comments or share your views in the Equitymaster Club.

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02:30		Chart of the day

The festive season is here. Those who are poor with dates would have got enough clues from the large scale advertising done by e-commerce firms. As per an article in Livemint, top 50 e-commerce firms have spent Rs 12 bn on television advertising in the quarter ended September 2015. This is apart from print and digital ads that together claim 60% of advertising budget. According to data released by TAM Media Research Ltd, this implies a 46.3% year on year (YoY) increase. With more and more e-commerce firms advertising on TV, the durations are going up consistently. The same has almost tripled during July -September 2015, as compared to January - March 2014.

Even if these firms score high with regards to gross merchadise value (GMV)of goods sold, final benefits are likely to be limited for them. The customers' lack of brand loyalty, lack of product/service differentiation and neck to neck competition between these firms offering mouth watering huge discounts is in fact likely to add to losses.

As e-commerce firms plan to list, those who claim the top slot with regards to GMV will make it a selling proposition. This is because there are no profits to talk about. And there are unlikely to be any for a long time we believe. As such, one would do well to limit one's engagement to shopping only and not invest in these firms.

Overall ad durations triple for e- commerce firms

03:30

The earnings season is upon us now. So far, since the wave of optimism pervaded the Indian economy, corporate earnings have disappointed. This is surprisingly in contrast with the macro data such as GDP. While poor corporate performance was unfortunate, it brought a much needed reality check for Indian stock markets.

However, the false positive alarms may not be over yet. Take the case of recently released capital goods production data. The same suggests 22% year on year (YoY) growth in the month of August. Not to mention a 14 month high. Finally, the government has got something positive to show on the report card. That may again lift market sentiments. However, investors must note that while the public capital investing has gone up, it has come at the cost of loosening fiscal deficit targets. With major global economies showing signs of vulnerability, India is unlikely to remain shielded. The stress in the banking sector, high corporate debt and unused capacities are not helping either. Hence, long term investors would do well to remain sceptical of any kind of recovery talk and investing themes and stick to bottom up approach of investing.

04:30

After trading on a flat note during the morning session, the Indian indices added losses and were trading in the red at the time of writing. Sectoral indices were trading on a mixed note with stocks from the consumer durables and oil and gas sectors leading the gains. However, auto and IT stocks were trading in the red.

The BSE-Sensex was trading lower by 42 (down 0.2%) and the NSE-Nifty was trading down by 17 points (down 0.2%). The S&P BSE Midcap index was trading down by 0.3%, while the S&P BSE Smallcap index was trading up by 0.3%.

04:55

Today's investing mantra

"There seems to be some perverse human characteristic that likes to make easy things difficult." - Warren Buffett

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