Long Term Investment Stocks–Making a 5 Stock Portfolio

The story goes somewhat like this:

Warren Buffett was once asked about the best investment advice he would give to a money manager just starting out.

He said, “I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities.”

Moderator Adam Smith protested, “But there are 27,000 public companies.”

“Well,” said Buffett, “start with the A’s.”

This without a doubt remains the best investment advice for me and I can safely say for all those who are serious about investing. Though, I agree 100 % with Adam Smith – you aren’t going to get to 27,000 companies. So where do you start? The good news is that in India, there are only about 5,000 listed companies. So I guess . . . . start with the A’s!

The above conversation took place when the world was a really strange place. News did not flow easily and information was not available as freely as it is today. In many ways, internet has changed the way people do things. Courtesy the internet, I am able to reach out to all of you.

The World Wide Web is filled with millions of pages of material on the various investing opportunities. There are many tools to help you research and scan a list of companies based on a range of parameter such as – Industry/sector, size/market capitalisation, location…shareholding…. you name it1.  So looking beyond the ITC’s and Reliance’s of the world is not half as difficult as it was a couple of decades back.

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To continue from where I left in the article above –

If you are looking for long term investment stocks, once you select a set of companies based on whatever your consideration may be (i.e. market capitalization, CAGR in profit, risk of investment vis-à-vis return etc) – 5 is the maximum number of stocks you should be actively holding at any given time. Sure you can diversify and add more stocks in your portfolio, but I think if you can’t get it right with 5, chances are, you will get a similar result with holding 15, or even more.

Holding 25-30 stocks at one time (the way mutual fund companies operate), could make your returns look very similar to fixed income investments. Personally, if I can get 9% return by investing in fixed income instruments and about 12% return in stocks, I would most likely choose a fixed income product like a bank FD. That is because I look for a much higher rate of return on whatever portion of my money I decide to invest in stocks. If I don’t see the opportunity of making at least 18-20% returns on my stock holdings, I don’t think that the risk-reward justifies an investment in stocks. Sure, the portfolio return may be well below my desired rate of return for a given year, but long term investing is based on the premise that over a period of time, your average return would be far higher.

[I]    SELECTING A SET OF STOCKS

•  Start your research by zeroing in on the industry / sector in which you want to invest (FMCG, technology, electronics, chemicals etc).
• Within this sector, select companies on the basis of their size (i.e. market capitalization) and / or past Return on Equity (ROE) record.

You can use one of the many tools to find companies based on industry/sector, market cap and on parameters of profitability and growth ratios etc. You can make a list of stocks for further research based on these parameters.

[II]    MAKING A 5 STOCK PORTFOLIO

2 things should be kept in mind:
First, you must carefully decide the portion of your total savings that you want to allocate to long term investment stocks. I have successfully followed the 100 minus your age rule for my equity allocation, which means that typically, 60-65% of my investible funds are in equities at any given time (I am 33 years old).

Second, the kind of stocks you select could change the very nature of your portfolio. Look at the three different portfolio sets below:
** I express no opinion on either of the above stocks or the nature of the above investments.

Clearly, based on the amount of money you allocate to stocks coupled with, the kind of stocks you choose could completely change the very nature of stock investing.

The kind of stocks you select should depend upon (i) your expected return; (ii) the risk you are willing to take (with your principal investment) to achieve that return and on (iii) the amount of time for which you can part with your money.

For me, a high quality portfolio of long term investment stocks includes – 2 safe well established companies, 2 upcoming mid-caps and 2-3 small lesser known companies. Besides that, I have no dogmatic investment philosophy something I have written about on other section of my site.

Related Reading – What do you need to be a successful Investor?

Not to say that I have no rules at all. I try to avoid extremely hyped companies – Companies which are already trading at high price earnings multiples, no matter how convincing the future growth story may sound. For example, one midcap stock, I may be interested in is Bharat Electronics at current levels (i.e. @Rs. 1054 a share). I think the company has an extremely interesting story and has clearly fallen below its historical PE averages (for reasons beyond my understanding). Similarly, for my small cap picks – I like companies which have market capitalization of below 300-500 Cr and are a ‘pure play’ meaning that one product or one service is all that they offer. Somehow, the concept of a well diversified small cap company does not work for me.

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