One of the biggest challenges in investing is deciding
when to sell stocks out of your portfolio. But did you know
that you're probably selling stocks
without even realizing it?
When not buying is selling
At last year's annual meeting, Chris Davis, manager of
the
Clipper Fund (CFIMX), argued that mutual
funds essentially sell some of their holdings in a company
when they choose not to buy more, and instead add a different
holding to the portfolio.
He used Warren Buffett's
Berkshire Hathaway as an example, saying,
"Every year that they didn't buy
Coca-Cola , they sold Coca-Cola. Coke became
a smaller percentage of their assets as new money came in and
didn't go into Coke."
In other words, as new money comes in and is allocated to
new positions, old positions have a smaller and smaller share
of the investment pie. So the influence an old position can
have on returns gets smaller and smaller, just as if some of
that position had been sold.
If you've ever added new money to your portfolio by buying
new holdings, the same thing has happened to you.
The big picture
Although we tend to talk about stocks one by one, how
they're combined in your portfolio is an important part of
investing. It's not enough to just add stocks to your
portfolio whenever you run across compelling ones -- you
should also be taking into account other factors, such as
your overall diversification and the size of various
stakes.
Fail to pay attention to the overall makeup of your
portfolio, and you might end up with a large chunk of your
portfolio in, say, oil-related companies or pharmaceutical
companies -- and if something happens in the industry
(imagine the price of oil plunging, for example, or unwelcome
health-care reforms), they could all take a big hit
together.
But you don't want your portfolio to get too big, either.
If you've added so many companies that each one makes up just
1% or 2% of your portfolio, a big home run from one stock
isn't likely to make a huge difference to your bottom
line.
That's why, as Davis suggested, adding more money and
companies to your portfolio, and therefore shrinking the
power of your existing holdings, matters.
Perfect your portfolio
Instead of distributing your dollars between
the stock that seems most promising,
the 56th most-promising stock, and all the stocks in
between, you want to concentrate your investments on your
very best ideas -- even when you add money.
Advisors often recommend holding between eight and 12
(sometimes as many as 20) companies in your portfolio. And
that means making sure that every investment really is one of
your very best ideas.
What constitutes a very best idea? For my part, it means
stocks with strong prospects and strong growth. Stocks with
solid dividend yields are a plus, too, and those with low P/E
ratios can be bargains. Screening is a good way to unearth
candidates for further research. For example, here are some
companies that popped up when I screened at Motley Fool CAPS
for companies rated four or five stars (out of five), with
revenue growth rates of at least 5%, dividend yields of at
least 2%, and P/E ratios of 20 or less:
Company
CAPS Stars
(out of 5)
Dividend Yield
3-Year
Revenue Growth Rate
P/E Ratio
AT&T
****
6.1%
29%
13
Procter & Gamble (NYSE: PG)
*****
3.3%
5%
13
PepsiCo (NYSE: PEP)
*****
3.1%
8%
19
Caterpillar (NYSE: CAT)
****
3.5%
6%
18
Verizon (NYSE: VZ)
***** Continued... |