Investors
do not really bother with the number of stocks in their portfolio. In
fact, the degree of diversification of their portfolio will directly
affect the investment performance. So the question is, should an
investor concentrate his capital in a few stocks or buy as many as 20
stocks?
I
can tell you that there is no one clear-cut answer to the above
question. The degree of diversification depends on which investment
methodology an investor practices. In this article, I will only cover
two investment techniques in the circle of value investing.
The Net-Net Hunters
Benjamin
Graham was the pioneer of this method. Net-net is a value investing
technique in which a company is valued solely on its net current assets.
If the share price is two-third of the net current assets (current
assets - total liabilities), the stock is considered undervalued.
They
focus on quantitative analysis - the figures in financial statements.
Little considerations are given to the future earnings power of a
company. Hence, net-net hunters always 'talk' to the balance sheet. Future
earnings is the key driver to the movement of share price, neglecting
the income statement implies greater risks ahead for the investors.
For
the net-net hunters, it is important to diversify and invest in more
than 10 companies. Thus, the net-net hunters need to buy more shares as a
means to reduce risks. In my opinion, they should own around 15 to 20
stocks in their portfolio.
Warren Buffett's Proponents
I
am in this category of value investing. As a Buffett's proponent, I
look out for companies with stable and increasing earnings year after
year. Although the balance sheet is important, but I put more focus on
identifying the company's true earnings power in the long run.
Hence,
the number of stocks that I intend to own is small, possibly in the
range of 5 to 8 companies. We do not treat the number of stocks in a
portfolio as a means of risk reduction, but most importantly, the
quality of each companies we hold plays an even bigger role in
minimizing our investment's downside risk.
Thus,
much time will be spent on dissecting a company's business risks. We
ought to invest in companies with the slightest risks of all. So, if we
own 5 companies with the slightest risks, chances are we will do well in
the future. Hence, concentration is the key for this group of
investors.
Conclusion
An
investor's preference on concentration or diversification of their
portfolio depends on the investment methodology. There is no one size
fits all method in the stock market. So which one are you? Happy Value
Investing!
