Great post, Don. Everybody does this differently.
I've found myself that the more confident I get that I know how to do this, the less valuable I find diversification. There are two or three stocks I find each year, but only two or three, that I am absolutely sure of. And 9 out of 10 of those work - I've learned to identify that "spider sense" and what it feels like when I know I've got one. And I've learned to buy those big. Big meaning 10-20% of a total portfolio. When I buy less than that I almost always wind up regretting it, thus turning a success into an error.
The danger to this without experience is that EVERY stock you buy feels like the perfect pitch at the time you are buying it. After a while I've learned to keep myself busy with small positions while waiting for that perfect pitch feeling about something.
I usually own about 20 stocks at a time personally. But they have VERY different weightings. Its taken me a long time to get to the point where I am comfortable identifying the sure things and putting 15% of my money into them - I wasn't there two years ago.
So my risk management strategy becomes very simple but chillingly precise - don't be wrong on one of these big bets. And you know what these sure things usually are - they're a stock I was early on and am down 25 or 30% or even 50% in - it is extremely hard to make something like that a big bet, but occasionally you've got to do it if you want to make significantly above market returns. But you can't be wrong - averaging down like that is a recipe for disaster if your analysis is in error. (I will almost never do this if a company has debt.)
Of course I am not allowed to do that professionally. Professionals (aside from hedge funds) are generally required to own at least 50 stocks, maybe more, with no more than 3 or 5% in each position. That cuts down on risk if you've got a manager who doesn't know what they're doing, but cuts down on reward if you've got one that does know what they're doing. I try to use weighting as a primary weapon professionally too, but there are all kinds of contraints, so I'm kind of limited to is this going to be a 3% weighting or a 1% weighting.
If you're looking for a good mutual fund, look for the kind of manager who has a great track record and owns 10 or 15% positions occasionally. Longleaf for example. What you don't want is a portfolio whose top 10 positions make up 10% of the fund - just buy the index.
Whoever suggested this topic for discussion, thanks, its been very fruitful already. I want to hear from Paul Senior on this before its done. Paul, is there a stock you don't own? What is a large weighting for you? What are the merits of that diversification vs. its downside in your view? |
