Tutorial 46-50 Recap
1) DIVERSIFICATION - while diversification is a worthy goal to protect capital, excessive diversification is likely to dilute returns. None of the Investment Masters made the list by investing in an index fund. It's better to have a solid understanding of 15-20 stocks than a broad understanding of 100-200 stocks. The benefits of diversification fall away once you move beyond about 15 stocks. It's important to understand the benefits of diversification will be nullified if those stocks are highly correlated.
2) INVESTMENT FACTORS - The Investment Masters understand it's important to focus on the three to four factors which are going to drive the companies business going forward. It is impossible to know everything there is to know about a company. It's important to spend your time thinking about what are going to be the key drivers that determine how the business will perform in the future. It is also important to understand the factors that are leading to an asset being mis-priced, such as analyst neglect, index implications, macro concerns, crowd psychology etc.
3) POSITION SIZING - there is no magic formula to determine the appropriate sizing for an investment. An investor must consider the downside risk to a stock and the implications to the portfolio should the worst case scenario actually happen. An investor needs to consider downside risk, portfolio concentration, correlations, liquidity risk as well as the risks inherent in the stock before deciding an appropriate size. Generally its considered wise to keep maximum position sizes below 10% of the portfolio. The Investment Masters generally size shorts significantly smaller given the additional risks of shorting.
4) PORTFOLIO MANAGEMENT - The Investment Masters understand that picking stocks and portfolio management are two different skills. The portfolio manager must consider, in addition to the inherent risks in each stock, how the portfolio will perform under different investing landscapes and were the risks of combining stocks are elevated. This includes analysis of the seven deadly sins of portfolio management - concentration, correlation, liquidity, leverage, overpriced assets, fraud and capital flight.
5) THINKING ABOUT MANAGEMENT? - Management is a key ingredient to a successful investment. The Investment Masters study the track record of management, what they have done versus what they said they would do. It's important that management understand the business and allocate capital in a productive manner. Management can add a significant amount of value to a company. It is preferable that management have the right incentives and that management have skin in the game.