Your stock portfolio is your company 1 comments

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One way to make measured judgments about our allocations within our stock portfolio is not to think of the merits of each stock within the portfolio individually, but rather to consider the portfolio on its own as a "company".

Too often we (including me) look at certain stocks and think to ourselves,"This is such an attractive valuation with such good prospects that I have got to buy it." And so we do, with available cash holdings. There is nothing wrong with this bottom-up selection process; however it tends to lead to arbitrary allocation of cash in various stocks depending on what is the amount of cash we had available when we spotted that stock opportunity. Thus the problem is with the asset allocation, not the stock selections per se.

One way I often employ to alleviate this issue is to think of the portfolio as a company (my company), and that the various stocks within are "subsidiaries" of the "conglomerate" which is effectively my stock portfolio. Several benefits, including psychological ones, are associated with this thinking:

(1)Cash allocation- It forces me to think top-down, rather than focusing on the stock per se. Qualitatively speaking, price movements can be said to depend on market, sector and company in even proportions. If the market is in a declining trend, what does a company with various investments do? Where possible, it goes to the safest asset - cash. Of course, an ordinary company can't do this because it can't always find buyers, and that's the beauty of the stock market - you can.

(2)Sector allocation- Again, top-down thinking but now focusing on the sector. Will you want your company to be comprising subsidiaries operating in sunset sectors or growth sectors? Clearly in the former one can find more compelling valuations, while in the latter there are more growth opportunities. Do you foresee some trends developing into trading themes in the foreseeable future, such that you want to position your "company" to take advantage of it? If so, how much of the company's "assets"? How many sectors/themes does the investor want his "company" to focus on? Within a certain sector/theme, how diversified does the investor want the assets to be (ie. one representative stock or many stocks in the same sector)? All questions that can be framed within the framework of a conglomerate's strategy, and no clear answers obviously.

(3)Risk-return profile- A company typically has slow and steady operations which net it good income but also nurtures subsidiaries in high growth potential areas. The former is typically low risk-low return, while the latter is the opposite. Does one want his "company" to be focused on fast growers (with more risk but more return) or to anchor it with stalwarts (with lower potential returns but more stable).

(4)Personal ownership- Thinking about your portfolio as your company gives you a sense of ownership towards the stocks ("subsidiaries"). It encourages business-like thinking about the stock other than its price. Consider: if a part of your business is doing badly, do you stay with it or do you exit? You will try to find out more, do some due diligence and attempt to locate the source of the problem, then monitor it. If it doesn't work out, then you can just liquidate it easily in the blink of an eye! (provided you don't buy illiquid stocks).

So, if being an entrepreneur is hard, then do the next best thing: invest in a multitude of proven enterprises and think of them as a collection of subsidiaries under your "conglomerate". Am I being Ah-Q or what?!