kcchongnz blog
Portfolio Diversification; My Experience kcchongnz
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.” Warren Buffett
“I like the idea of owning a number of stocks. Warren Buffet is happy owning a few stocks, and he is right if he is Warren….” Walter Schloss
The stock market is the best place to build up long-term wealth. I have articulated this here:
http://klse.i3investor.com/blogs/kcchongnz/59971.jsp
http://klse.i3investor.com/blogs/kcchongnz/62293.jsp
http://klse.i3investor.com/blogs/kcchongnz/64525.jsp
However, investing in the stock market is a very risky endeavor. First one must a good understanding of the language of business as he is investing in part of it. Even though you understand well and have done thorough analysis on the business of a great company you invest in, there is no guarantee that your investment will appreciate in value. In fact there is no guarantee that you won’t lose money and can even have your investment down by 30%, or even 50%, especially in the short term.
Every investment is subject to the influence of fear and greed in the market place. The duration, intensity and frequency of the unexpected changes of the macroeconomic, sectors and political situations are very difficult to predict. Some sectors of the market will do well while others falter. For example, export stocks seem to be doing very well now and their share prices have risen to all-time highs, while property and oil stocks are lagging behind. However, these sectors could flip-flop suddenly. The once-strong sector could fall and the once-poor sector could gain. Nothing is completely safe.
Simply put, there is no free lunch in investing. Risk and return are generally intertwined. Focus investing in just a handful stocks in one or two sectors with all your wealth can provide you with outsized return if your bet is right and continues to be correct. Some investors have made a lot of money, at least on paper, this couple of years buying all furniture stocks. Many new comers, attracted by the continuous rise of the stocks follow suit, chasing their prices higher and higher. A turn of event due to unforeseen circumstances could hit you hard with devastating outcome.
Three to four years ago, some investors were so bullish and utterly confident about plantation stocks, touting a couple of them as “the most undervalued stock in Bursa, or in the world”. Some also even encourage speculators to use margin finance to bet bigger for prospective amplified gain, while completely ignore telling the fact that the game could have equal chance to go the other way. They placed all their bets in this single sector, and got burned badly holding those plantation stocks while the rest of the industries were flying high.
Similarly, we have had our most recent experience in investing in the oil and gas stocks last year and when oil price plunged abruptly, the related stocks tanked, and many investors having focus portfolio of just a few stocks in this oil and related industries were hurt badly with the value of their portfolio fallen more than half in just a few months.
The stock market is unknowable. It is unpredictable, and it is full of uncertainties. Overconfidence causes one to concentrate investments in a single stock or a single sector and fail to have a diversified portfolio of stocks in various sector in case he may be wrong. I have personally seen how wrong one had gone into for lack of diversification in his stock investments and placing all his bets in just a handful of stocks he was so confident of, very wrong and devastating indeed.
Portfolio diversification
Academicians and practitioners alike do believe there is a kind of free lunch in the market, i.e. in portfolio diversification. The popular adage of "Don't put all your eggs in one basket" is a best known proverb informing investors to the importance of portfolio diversification to cutting the risk. It advocates diversification, a technique that reduces risk by allocating investments in a number of stocks in the portfolio. Ideally the stocks chosen should be spread over different sectors and industries that would each react differently to the same event.
Figure 1: Reduction of idiosyncratic risk
As the number of stocks in the portfolio increases, the variation of return reduces sharply initially as shown in Figure 1 above. Studies and mathematical models have shown that maintaining a well-diversified portfolio of about 20 stocks will yield the most cost-effective level of risk reduction. You do not need to own hundreds of stocks to achieve a good diversification, and a portfolio of about 10 stocks for ordinary investors, and may be about 20 for a portfolio worth tens of millions of Ringgit.
Why diversification is important? My personal experience
In order to avoid being branded with degratory terms such as bullshit, misleading, empty tong etc. I always use the portfolios of stocks which have been publicly avaliable in i3investor to illustrate my investment points and strategies. Those provide evidence that these were the stocks actually chosen years ago by me with those said prices.
Readers would have noticed that often I have been using my first portfolio set up on 23rd January 2013, named as “GE 13 Watch - Kcchongnz (revised - 20 January 2013)” put up in i3investor by Tan KW, another forumer. This is because this is the oldest public portfolio of mine in i3investor. The last few times I used it are shown in the links here:
http://klse.i3investor.com/blogs/kcchongnz/85100.jsp
http://klse.i3investor.com/blogs/kcchongnz/84923.jsp
http://klse.i3investor.com/blogs/kcchongnz/83320.jsp
In this article to illustrate the benefits of diversification, I would like to use the stocks in another published portfolio of mine in i3investor, My Second Portfolio, also published by Tan KW, as at that time, I didn’t have my own blog within i3investor yet.
My Second Portfolio
Tan KW initiated another “challenge” named “Stock Pick Challenge 2013 2H” starting from 1st August 2013, just after the first “GE13 Watch” above. There were only two entries then, mine and another by Ooi Teik Bee. I have chosen a diversified portfolio of 11 stocks of different industries as compiled in the link here:
http://klse.i3investor.com/servlets/pfs/19386.jsp
In this “Stock Pick Challenge”, I have provide written justifications on my investment thesis, including the valuation on every stock chosen as shown in the link below for sharing and discussion purpose.
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp
I walked the talk and invest myself on those stocks I have written if I think they are good stocks to invest in at the right prices. Sorry, I don’t have to show you any transaction sheets to prove that for those who asked for them the last time.
There are three particular stocks in the portfolio which I would like to elaborate; Kumpulan Fima, Haio and Daiman Development.
At the time of writing, Kumpulan Fima has a high return on invested capital (ROIC) of 19%. At RM2.06 then, it was selling at a very low PE of 7.2, and an enterprise of just 4 times its earnings before interest and tax. Besides, it has a cash balance of RM1.00 per share. This was essentially a great company with high performance and abundant cash in its balance sheet, but selling at dirt cheap price.
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/34118.jsp
Kmpulan Fima’s share price has dropped to RM1.80 with a loss of 5.8% at the close last week on 13th November 2015, while the overall market is practically flat during the same period.
The next stock, Haio had high Magic Formula score with ROIC at very high at 29%. At RM2.72 then, the other component of Magic Formula Earnings yield was also high at 14.4%. Haio certainly fit the criteria of a good company. My discounted cash flows analysis gave an intrinsic value of Haio at RM3.82, or a margin of safety (MOS) of 30% investing at the price then. The estimated intrinsic value is still much lower than its peak of more than RM5.50 before the US subprime housing crisis.
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/34285.jsp
Haio closed at RM2.22 on 13th November 2015, still with a loss of 9.4%.
Daiman Development’s investment thesis is based on the balance sheet investing of Graham net net asset valuation. My asset valuation shows Daiman has a net asset backing of RM4.85 per share and a net net value of RM3.76 per share. Using the Katsenelson absolute PE valuation, I had an intrinsic value of Daiman at RM3.90.
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/35908.jsp
Wasn’t Daiman dirt cheap at RM2.53 then?
Daiman closed at RM2.29 on 13th November, 2015. There is still a loss of 9.1%.
All the three stocks appeared to be very good stocks selling at great prices to me two years ago. I would have included all these in my focus portfolio of just three stocks, if I were aiming for a concentrated portfolio, and the result would be I would be holding a portfolio with an average loss of 8%, while the broad market was flat during the same period. It would have been a not-so-big loss though, as the stocks were chosen following some established investment process and strategies with safety first in mind, but there would be some additional loss in opportunity costs.
Fortunately, these three stocks just formed 27% of my diversified portfolio of 11 stocks in My Second Portfoliio.
Return of My Second Portfolio as to date
After 27 months have passed as on 13th November 2015, the average return of the portfolio is 111% and a median return of 46%, instead of a loss of 8% in a concentrated portfolio of three stocks, as shown in Table 1 in the Appendix, compared to the flat broad KLCI during the same period. Out of the 11 stocks in the portfolio, 8 are in the positive return territory with two of more than 400% return; Datasonic at 521% and Homeritz at 424%.
There is no evidence that the portfolio of stocks selected are more risky than other stocks.
I am happy with the results. Invest in a diversified portfolio of stocks with the outcome of more positive returns (73%) than negative returns (27%), and a couple with outsized returns while the negative returns are minimal at single digit loss. That is the result each investor should strive for in investing for long-term wealth building.
“Take care of the downside, and let the upside takes care of itself.”
Conclusion
I conclude here with what Seth Klaman said:
“You need to balance arrogance and humility…when you buy anything, it’s an arrogant act. You are saying the markets are gyrating and somebody wants to sell this to me and I know more than everybody else so I am going to stand here and buy it. I am going to pay an 1/8th more than the next guy wants to pay and buy it. That’s arrogant. And you need the humility to say ‘but I might be wrong.’ And you have to do that on everything”
Stocks diversification is a form of exhibiting humility, an admission that we could be wrong sometimes. It won’t ensure gains or guarantee against losses but strives to smooth out unsystematic risks of companies in a portfolio which are not perfectly correlated so that the positive performance of some companies will neutralize the negative performance of others.
Stock diversification into some quality businesses, but not overly diversified, appears to be the only free lunch in investing. Don’t you like free things?
For those who are interested to build up a diversified portfolio of stock for long-term wealth building in a safe manner, please contact me at
K C Chong
Appendix
Table 1: Return of My Second Portfolio
Prices are adjusted for dividends and corporate exercises, if any, as obtained from Yahoo Finance
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Discussions
6 people like this. Showing 39 of 39 comments
Probability,
Thanks for your comments.
Taking your analogy, it seems that there are 7 red in a pail, and some pails have 8 red marbles.
The more interesting thing is when you draw a white marble, you get a fine of $10. But you get a red market, you are rewarded with $100.
Isn't this a great game to play?
2015-11-16 07:53
Posted by jassmen > Nov 16, 2015 01:36 AM | Report Abuse
KC,
Table 1. What the meaning of Ad price?
It is adjusted share price after dividends and corporate exercises. I got it from Yahoo Finance
2015-11-16 08:48
I slowly accumulate more of MMODE..... in order to Tua Huat lah... ha ha ha.... all the way up from 33 sen.... huat lor... ha ha ha for those of you not yet Diversify to this counter can always do so... as it is NOT LATE yet.... ha ha ha
2015-11-16 10:21
TO: Probability
Just my opinion.
1. In the long run, only if you are "lucky" the red marble selected will give you some little rewards or none. The higher probability would be to wipe out your principle investment by a tonne, hence being a red marble.
2. Instead of increasing the number of pails, why not increase the selection in the current pail from 1 to say 2 or even 3? Study the stock and do the necessary research until you are fully satisfied that your reasoning/rational for buying the stock with a solid basis as opposed to finding a new batch of stocks to filter. A stock which you have done your homework previously may not be a good investment at that point in time, BUT given the right circumstances may be an excellent investment later. So don't disregard the stock which you have have filtered out just yet.
2015-11-16 10:28
Leno...look at the pail like a random mix of 6 red and 4 white which you can only pick at the end of the year (and place it back!). If its red you get the gain as per the amount you bet. Say you bet 100 if it red , you gain 100 if its white you loose 100.
Now given choice, scenario 1 - you can bet on red with RM 1000 every year, or Scenario 2 - bet 10 pails (10 picks end of the year) with bet amount of 100 on each pail.
By end of ten years, theoretically on scenario 1 you would have lost 4 times (lost 4000) and won 6 times (win 6000). Gain = 2000 in ten years.
In scenario 2, its like every year you make 200 and the return end of the 10 years is the same, i.e you made 2000 with a capital of 10000 (20% gain).
On second scenario...you did realize 20% gain every year. That means you are getting the results of 'what you believe' faster.
Now...of course its good if you can find as many stocks where you 'believe' it contains '6 red and 4 white', even more so with '8 red and 2 white' coz you return will be higher...
but invest 'as many similar stocks' you can find to prove your believe every single year.
2015-11-16 11:29
Yup KC, you Financial statement based investing definitely look like you can find ' 8 red and 2 white ' pails...and the gain appears way higher than the loss, so its more like 9 red and 1 white..he he
2015-11-16 11:31
bottom line is ... diversification is to cover our ass .... from misfortune. Nothing to do with getting result faster. It is like insurance. Onli a fool want to buy life insurance to make money. Insurance is to cover misfortune. Unforseen bad luck.
2015-11-16 11:49
leno..i agree the general concept of diversifying is to dampen the damage if it occurs...but then it also dampens the gain.
Here I am talking more about greenbalt strategy...on having a certain belief and having a number of portfolio to realize your expectations. If you are investing only on 1 or 2 stocks and hold to it...you may never get the return as per your believe in your lifetime. (OR you can achieve higher than expected - but I don't need that).
Your argument on scenario 1 & 2 is possible...everything is possible but which is a 'more sure way' to get the outcome as per your belief on the content of the pail - as obviously when u buy the stock you have a certain belief (strategy) and you just want to realize it faster. I don't need 30% CAGR, I only need 15% but I need a sure method to get that. If you only need 3.5% CAGR then you can invest in FD.
all greenbelt wants is say 15% return per annum, and then he wants to compound it by changing portfolio every year.
2015-11-16 12:29
no ... diversify does not increase the "sure way" or fastered your believe. Diversify does dampen the gain in exchange to reduce risk of getting wipe out in one go for being unlucky. MEaning if u put everything into one stock, and something unrelated happen like earthquacke which destroy the whole company, u will be totally wipe out even though the company is very good. So, before u put everything in ONE stock, we must ask can we accept the risk of the stock being totally wipe out by unrelated circumstance.
On this i will like to recall my experience by putting everything in one stock called ANALABS in 2007, reason was i can't find or no time to find other good stock to diversify into, and i believe i can accept the consequences of the stock been wipe out because i was still actively working as doctor with very stable income ... it did not dampen my believe in value investing. It did not slower my outcome of my believe too. On the contrary to what u said ... i actually realised my gain fastest than those who had diversify.
Now, the moral is diversification does not increase your gain, does not speed up your believe, does not improve the sure way. But yet We must diversify if "AVAILABLE" "AND" "AFFORDABLE" after observing the first rule of "Margin of Safety"... in 2007 scenario of MINE ... there were no value stocks "available" for me to diversify into due to time and energy constraint.
2015-11-16 13:19
The only thing consistent about the market is its ability to surprise. Very little analysts foresaw the subprime crisis, and even less predicted the collapse in oil price. Diversification enables one to absorb the shocks market throw up without wiped out. I buy great companies in industries with shitty prospects for diversification. I hold Yangzijiang, a Chinese shipbuilder, and CNMC Goldmine, gold miner in Kelantan. Both are in shitty crappy industries but both continue to defy the negativity of their respective industries through much better financial results than their peers. Share price will probably remain depressed for extended time but as long as I can sleep well it's OK.
2015-11-16 19:04
You will surely sleep well! If the money you invested in stocks is not for your breakfast,lunch,dinner, your retirement fund or your kids education fund.
2015-11-16 21:53
Mr kcchongnz, you have a lot of shares with different number of stocks, all has good and healthy balance sheet but never see you holding any MARCO which has a very strong balance sheet and is cash rich. I wonder why?
2015-11-17 11:02
Posted by m00077 > Nov 17, 2015 11:02 AM | Report Abuse
Mr kcchongnz, you have a lot of shares with different number of stocks, all has good and healthy balance sheet but never see you holding any MARCO which has a very strong balance sheet and is cash rich. I wonder why?
There are hundreds of stocks having healthy balance sheet, but why must also own Marco? Do I have that much money?
Bear in mind what Warren Buffett said,
"You can't make a good deal with bad people"
That is why I never look at Marco again.
2015-11-17 13:29
Nice to hear your response. I don't understand you mentioned "bad people" refers to what/who?
2015-11-17 13:41
Posted by m00077 > Nov 17, 2015 01:41 PM | Report Abuse
Nice to hear your response. I don't understand you mentioned "bad people" refers to what/who?
Just ask around has anybody make any money investing in Marco?
2015-11-17 14:15
Just exercising my brain here….too much free time….
Say you have machine gun that fires on a wall taking bullets randomly from a reservoir of bullets either made of gold or silver bullets automatically.
The reservoir has a certain fraction of gold bullets, say 65% gold and 35% silver, unknown to the person firing it or the spectators looking at the bullets fired on the wall.
If the machine gun fires only 2 bullets in a year, in 10 years it could have fired all gold bullets (20 of them) or perhaps 14 silver and 6 gold.
Say, you are a person who has the knowledge of the reservoir content exactly, you would have definitely bet on gold bullets hitting the wall, but due to the limited ‘incidents / verification’ done, as per above scenario you could have got the results exactly as per your prediction or more than you had predicted (all gold) or less than what you had predicted (14 silver, 6 gold) due to bad luck.
Now if the firing were done say 100 times a year, the ‘certainty’ is very high that you will get the results on the wall exactly as per your prediction, i.e 65% gold (not more not less) as per the knowledge advantage you had on the reservoir.
I am viewing the results of a particular stock end of the year as the firing of the machine gun (this is subject for further scrutiny). The more ‘similar’ stocks you own , the much ‘faster’ you can realize the results as per your prediction. Note I am not saying gain here, I am saying if you had selected a stocks with 2 gold and 8 silver, you will also realize their true characteristics faster.
(this may apply on greenbalt strategy, I am not talking about risk aversion where at least more than 5 stocks reduces you risk significantly, I am saying if you sure the gold bullets are much higher than then silver, buy as many similar stocks you can)
If we say that by buying a number of stocks will dampen the gain or loss, isn’t this concept is based on the same argument that the more firing you will have the more you will see the true characteristic of the stocks at large. The more you have the more it will represent the true average content of the golds and silver bullets of all stocks combined. Why can't 2 or 3 stocks represent the whole market?
I think the key thing here is finding a strategy to be sure on the content of the particular stocks, ensure that the odds of gold bullets is way higher than the silver bullets as per your expectation and find as many similar stocks to invest.
You may find only 3 stocks with 7 gold and 3 silver, and you may find 20 stocks with 6 gold and 4 silver. I am happy to invest on the 20 stocks and be certain that I get the return as I had wanted end of the year than investing only on 3 above which may turn out to be way higher than I had expected but I it does not give me the certainty I want that I will get it.
2015-11-17 15:16
No movement at all for "Macro". For those who own this stock just kept into the fridge.Really bad management
and bad people
2015-11-17 16:40
Why no. of firing = no. of stocks?
Coz I believe each stock has a certain cycle time for catalysts to act on it to reflect its Intrinsic value and the time is approximately the same for each stock. So, more stock means more incidence of catalyst effects.
Contents, the gold bullet fraction = MOS , margin of safety after calculating its Intrinsic value
2015-11-17 22:47
To those who think KC Chong is great here he lost over RM 100K punting in Maybank C6. Hence he said he not rich or no money.
http://klse.i3investor.com/blogs/kcchongnz/58905.jsp
2015-11-18 03:14
Basically u are actually arguing in psychological term instead of probability. If u can calculate the probability of 1 over 6 and 10 over 60 .. u will know both are the same. U will not choose 10 over 60 claiming 10 over 60 is better or faster compare to 1 over 6.
Now, how about psychological term. Does 10 over 60 give better perspective compare to 1 over 6 ? The answer should be NO. If u understand probability, psychologically u should know both are the same. If don't understand probability, 10 over 60 or 1 over 6 are just a meaningless arguments.
... Let's go to your machine gun analogy. If u fire a pistol with 10 bullet Even though u point to right direction, there are chances u onli hit 1 bullet and miss 9 and u may be misled by the result and think u have pointed at wrong direction.
... So, u say u should use machine guns which fire 100 bullets. And might get 10 bullets hit. I ask u lar ... if u fire 100 bullets and ONLY 10 hit the target ... another 90 missed ... Doesn't this gave the same psychological effect as hitting 1 out of 10 bullets ? And u WILL think u have pointed at wrong direction because u MISS 90 out of 100 shots !!!
IT IS THE SAME !!
2015-11-18 08:46
ok ok leno....fine.
I am just trying to figure out why Greenbalt suggested to 10 or 20 stocks under the Magic formula portfolio ( this I believe is not purely risk aversion).
I thought he is trying to ensure he has a consistent return ~min 15%
and make use of the 'power of compounding'.
2015-11-18 10:22
Find what works for your personality and use it. I hate diversification. But thats just me. I prefer to identify and build large positions in one or two counters. Suits me, but may not suit the small investor.
2015-11-18 10:43
FYI, I'm with KCNZ and am not dumb enough to buy into the SPAC nonsense/BS. It does not mean that 'certain people' had some fun and made some serious money on the initial 'buzz'.
2015-11-18 10:47
a bit more about the word "AFFORDABLE"
It means in financial term and ability term.
Financially mean .. u enough money to diversify or not. Can u buy 10 4d number with rm 5 ? Can ?
Ability mean ... how many stocks u can follow in term of value investing monitoring. Some can onli keep track of 5 companies some can keep track of 50. Peter lynch can keep track more than 100 stocks. I got a millionaires friends who can keep track 50. Some of them work in teams. And some who life is center over share market meaning no other life other than share market. No famili, no kids, no exercise, no movies etc.
Whereas leno can keep track up to 10 stocks. But sometimes onli up to 5 due to TIME constraint. For example, now leno am BUSY training for leno first full marathon.
So ... got understand ? eLLLLLOOO .....? Any brain matter inside your head ?
2015-11-18 11:04
Will they learn faster that buying 4d is a losing game if they put RM 10 in each 10 numbers compare to another punter who put rm 100 in one number ?
on the above question - a logical person would learn faster by putting 10 in each 10. An emotional one wont figure it out la....
Your 'available' theory is quite in line with I said..
when you can find a stock with more gold bullets than silver as per your expectation just buy if you have the money..
so then you do agree to have more of the good stuff as long as the goodness level meets your criteria / min threshold.
2015-11-18 11:04
hey on the 4d, a logical person would not even buy it in the first place....
2015-11-18 11:06
NO !! U got buy 4d number or not ? Buying RM 10 in 10 numbers DOES increase chances to hit the prize ! So, it can re-affirmed the WRONG belief. The catch is the higher chances to hit is "counter" by lower prize payout receive. Hitting a prize with rm 10 bet compare to RM 100 bet is different. Understand boh ? Same like your 10 stocks with higher chance to hit but because of less holding will counters your believe compare to the one who hold 2-3 or even one stock ! How many time i need to repeat this !! GILA !! GILA !! USELESS ! BRAINLESS ! I am out of here ! No more tok kok about c2peed thing . .. kepp goin incircle !
2015-11-18 11:12
ok good that u surrender leno...
I think u might had an incident on the microwave! :)
2015-11-18 11:13
Posted by CCCL > Nov 16, 2015 09:53 PM | Report Abuse
You will surely sleep well! If the money you invested in stocks is not for your breakfast,lunch,dinner, your retirement fund or your kids education fund.
Yes, more so don't use other people's money to invest or speculate in the stock market.
Stock market is full of uncertainties, it is unknowable.
Having good sleep is a good investing strategy.
2015-11-18 17:03
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Probability
KC I am just bringing the ‘time we have’ factor into the Diversification topic as much I could understand.
I think when we buy a particular stock based on our perceived Intrinsic value (purely based Financial statements), at much cheaper price with high margin of safety, it’s like you are betting on picking a red marble (blindfolded) in pail of 10 marbles with 6 red marbles and 4 white marbles. There is something fundamentally right (logically right) that you will win (or gain).
Coz you believe the odds of this stock moving at higher pace than others is higher.
If we are betting only on one pail…say picking one marble once a year…you may even get the results to be white marble for ten consecutive years, though theoretical (also practically) in the long run you will Win eventually by betting on red marbles – precisely as per the odds 6/10 for red marbles.
So, by increasing the number of pails, I think we are just making the results appear much faster…as obviously we do not have 100 years to prove our prediction is right.
Now, that means the more pails you have the more smoother you return would be exactly as per the odds. But , that depends on ‘how many such pails’ (which you are sure it contains 6 red and 4 white) you can find….guess this is what Warren is saying by ‘know what you are doing’.
Quantity of pail in portfolio is inversely proportional to ‘how sure you are that you know the content of the pails’. The other extreme would be just betting on the Composite Index for one who has zero knowledge.
2015-11-15 18:04