Tuesday, September 23, 2008

Value Investing Today: Chp 11: Managing Risks and Your Portfolio

Brandes defines investment risk as the potential of losing money. He suggests that a portfolio needs to be designed to limit risks. Short term fluctuations in stock prices is not risk by his definition, since value investors invest with a relatively long time horizon and at a stock price that makes economical sense.

Brandes suggests to always to weigh a businesses value against its stock price. You can control risk by buying a company significantly below its intrinsic value. If a stock rises above its IV, sell the stock, if it's a good quality company and trades below its IV with a margin of safety, buy it. You can also control risk by diversifying across countries and industries. This diversification is not done with the purpose of reducing short term price volatility, but rather, to prevent a poor performing investment from significantly dragging down the overall portfolio's return.

To properly diversify, Brandes recommends to not place more than 5% of your portfolio, based on cost, into any one stock. Also, he advises to not invest more than 20% of your portfolio in any one industry or country. Brandes suggests that even diversifying across 10 stocks can reduce your portfolio's risk by 90%. He also mentions that holding even a hundred stocks is fine, provided that each company investment meets the criteria of having its stock price trading significantly less than its underlying business value.

Brandes feels that fears of buying stocks that have low share liquidity are largely unfounded. Over the long term, companies' fundamental value will get recognized in the marketplace. People's fear of liquidity amounts to worrying about whether they can quickly exit an investment without incurring a negative price impact in the process of selling. Brandes points out that this is of concern to short term traders, and possibly very large money management firms, not for the majority of value investors. He references Buffett who wrote "only buy a stock that you would be comfortable owning if they closed the stock exchange for three years tomorrow".

Lastly, Brandes is not a proponent of dollar cost averaging for value investors when buying individual stocks, since it could violate the basic value investing tenet of only buying shares when the price is less than the underlying business value (with a margin of safety).

No comments:

Follow by Email