Block 27: What to Focus On
Now that you’ve found your edge and you know which documents to start your research, what do you do next?
One of our biggest pieces of advice is: build your pattern recognition. What this means is look at a lot of companies. As you research and become familiar with more and more companies, you begin to build a mental rolodex of different company metrics and the industries they are in. It also helps to keep an excel or even a paper notebook to keep track of the financials of individual companies.
One thing that really helps is keeping track of quarterly results. If you click here, we have included the outline to an excel sheet that will simplify this process. You can get quarterly data by googling the company you want followed by “investor relations.” Then, you can navigate to the company’s press releases or quarterly data and fill in your notebook or excel sheet.
We suggest recording at least the last eight quarters of financial data. At least note the revenue per quarter and the operating income/loss. If you have the time, do free cash flow as well. It will take a while but if you are serious about making money over the long run, it is a small price to pay. This gives you a good reference point when you read the next earnings transcript to see the quarterly results. This way you have a little bit of context to see if the results your company reported are in-line, better, or worse than the past results.
The second thing to focus on is your style of portfolio management. Portfolio management is just how you determine your allocation of individual stocks. For instance, if you own equal value amounts of only two stocks, they will each have 50% allocations. There are two main camps in regards to portfolio management, though there are surely more. The first camp focuses on diversification. Diversification is spreading your bets out to lower to risk of the portfolio. If you only buy Amazon’s stock and Mr. Bezos flies to Mars and never returns and the stock plummets 80%, diversification would have helped you out. If, for instance, you owned 50 stocks, equally weighted, Amazon going down 80% would have only put a 1.6% dent in your portfolio. This is a whole lot better than an 80% dent. So this camp says you shouldn’t put all your eggs in one basket because you just never know.
The second camp is the di-worse-ifiers. This group believes that you should hold a select number of companies, know that group extremely well, and not “di-worse-ify.” Di-worse-ifying is diversifying for the sake of diversifying rather than strategically limiting your risk. In other words, would you rather put money in your 100th best stock idea for the sake of diversity or more money into your best idea? This method would argue that you might put your eggs in a few baskets and then watch those baskets very carefully.
Both sides have valid arguments but different priorities. The first group values risk management and the second group values return. Here is the thing though. If you are just starting out as an investor, you should probably go with diversification. As you build up your skills, you may be able to concentrate your portfolio. The great thing about commission-free brokerages is that it allows investors with a little bit of money to diversify because the fees don’t cut into the value. At the same time, when starting out, it is tough to follow a whole bunch of companies.
Based on the amount of time you have to follow companies based on work, school, child-care, or other responsibilities, you can build your portfolio management style. The more time you have, the fewer companies you can hold. This is not to say you should just buy subpar companies if you are diversifying more, you just don’t need to know them as well versus concentrated portfolio.
What we have found is that even 15 companies is a lot to follow closely for one person. And if you hold more than 50, you might as well buy an index fund. But also, holding fewer than 5-7 requires incredible analytical skills and foresight. Here is a makeshift outline to follow. See where you would fall. As you learn and grow and have different priorities, you can always switch styles.
# of stocks
1-4 – stock genius or investing with under $1000, playing with fire
5-10 – concentrated, need a lot of time and effort to know companies
11-19 - fairly concentrated, in the middle of both camps
20-25– difficult to keep up with but gives more diversity
26-50 – prioritizes risk management and likes to learn about different businesses
51+ -- buy an index fund
So now we have a better idea of how to track the financials for our stocks. Plus, we know the criteria for how many stocks we should hold. Now we will move on to what we, as investors, should do on a daily basis…