My Personal Finance Journey

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Reengineering My Portfolio Management, Part VI: My Individual Stock Portfolio -- The Buy Side Considerations

Contributed by mm | February 21, 2007 12:56 PM PST

As I explained in previous posts, I plan to devote about 30% of my portfolio to individual stock picks in the U.S. market, primarily focusing on large-cap companies. While this will certainly require a lot of time investment to do it right, I do expect to derive a lot of satisfaction by learning different businesses, crunching the numbers and achieving some dependable absolute returns.

My Investment Philosophy

I mostly characterize myself as a value investor. In short, I believe in:

1) Picking up a good stock with enough safety margin is the formula to investment gains.
2) The stock market is not fully efficient and will present opportunities from time to time.
3) Patience and long-term approach is important, both for buying and selling.

Number of Stock Picks and Average/Maximum Size of Investment

I do recognize each additional stock adding to my portfolio will be an extra tax on my (very) limited bandwidth. Therefore, I do intend to hold an average of 10, but no more than 15 individual stock positions at any point of time. 10-15 stocks seem to be the right balance between time investment and diversification.

Using 10-15 stocks to cover 30% of my portfolio means each stock, on average, will represent 2%-2.5% of the size of my portfolio. At my current portfolio size of $744,000 (as of January 31, 2007), this means the size of an average position will be around $15,000 to $19,000 for now. (This number will certainly grow higher over time.)

Also, I will ensure no single position should represent more than 7% of the total portfolio. This way, a sudden 15% drop in one stock (quite highly unlikely for blue chips I am focusing on) will bring no more than 1% decline of my portfolio. Quantitatively, the 7% threshold means no single stock will exceed more than $50,000 in value for now.

How Will I Pick Up Stocks?

In the last few months, I have been practicing and perfecting my screening process that includes four steps:

1. Ideas Gathering: Write down names of interesting stocks from everyday personal finance readings (WSJ, personal finance magazines, etc.).

2. Basic Research on Stock Ideas: Conduct some basic research using S&P report, Morningstar (paid Premium membership) and Value Line (paid subscription) on each stock idea and define a target (buy) price (primarily using a stabilized EPS or FCF/S * Conservative Multiples * Discount Rate). Each stock idea with a target price will be kept in my watch list.

3. Watch List Monitoring: Weekly or more frequently, I compare the current price with my target price in each issue in my watch list, and single out those who are turning favorable prices. On a monthly basis, I try to keep updated of latest news on those companies approaching my target price, and update my target price when necessary.

4. In-Depth Research Toward Go/No Go: I then conduct more in-depth research of each promising candidate by reading SEC filings, stock research reports (free Smith Barney, Lehman Brothers and Prudentials reports via my brokerage accounts), and sites like Fool.com and SeekingAlpha.com. The purpose of this step is to ensure I can make sense of the company and understand the math. Only those that still leave me with a warm feeling after these hours of readings and number crunching will get the nod.

While I am still evolving the process over time, I think the current process allows me to expand my knowledge over a growing list of good companies (BTW, Morningstar stock report is an excellent one-stop resource for initial research), and always be able to catch opportunities on those companies I researched before. Hopefully over time I can build a longer and longer watch list to catch more deep-value opportunities.

(Since I started to test this process in November, I have made three purchases: Apollo Group (APOL) on November 20 @ $35, ConocoPhillips (COP) on November 23 @ $64 and Marsh & McLennan (MMC) on February 15 @ $29. Time will tell if those bets are on the right side.)

Next: How will I sell stocks?

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