3 Fundamental Elements of Portfolio Management


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Have you ever noticed that most of the difficult goals in life come with very simple solutions?

You want to lose weight? Eat less and focus on healthy foods, and train more.

You want to build a business? Identify a problem and offer a solution.

You want to retire stress-free? Pay yourself first and invest systematically.

You want to travel the world in your 30’s? Buy a RV, quit your job and start your adventure!

Those goals are all considered “difficult” to achieve because they require you to follow a simple methodology for a long, long time! Consistency is the factor most people ignore when going after a specific goal.

You must always eat healthy food and workout 4 days a week.

You must work relentlessly to improve your solution and spread your message.

Paying yourself or going on vacation and fancy yourself with some cool clothes?

All right, my last example was just a crazy tip! Yet it was simple and still difficult to achieve!

Investing is no different. To succeed, you must follow a simple solution. The clearer and more detailed your methodology is, the easier it is to stick to it and avoid mistakes. Today, I’ll share with you three fundamental elements you should always consider when managing your portfolio.

1. Cautious about the Valuation

Valuation does play a major role in the buying process. However, this should not be the single factor that determines whether you buy. This is one factor among many. To be honest, I would rather buy an “overvalued stock” with a strong dividend triangle, great growth vectors and lots of potential for the next 10 years than buying an “undervalued stock” that has nothing else but a good yield and a poor valuation.

When I find a company I really like, but the valuation seems ridiculous, I’ll be tempted to put it on a watch list and wait for a while. I usually build this watch list on the side and when I’m done with one of my current holdings (e.g. the company doesn’t meet my investment thesis anymore), I pull back the watch list and check if valuations have changed. Once again, I’ll pick any “Microsoft” (overvalued, strong growth) over any “Exxon Mobil” (undervalued, modest growth) of this world.

I use mostly two methodologies to determine the stock valuation. The first one is to consider the past 10 years of price-earnings (PE) ratios. This will tell you how the stock is valued by the market over a full economic cycle. You can determine if the company shares enjoyed a PE expansion (price grows faster than earnings) or if the company follows a similar multiple year after year.

When you look at stocks offering a yield of over 3% with a stable business model, the dividend discount model (DDM) could be of great use. Keep in mind the DDM gives you the value of a stock based solely on the company’s ability to pay (and grow) dividends. Therefore, you will find strange valuations when you look at fast-growing companies with low yields (e.g. Visa!).

While the idea of receiving dividends each month is seducing, this is not what makes dividend growth investing magic. It’s the combination of capital growth and dividend growth (read total return) that truly generates the magic in your portfolio.

2. Never Skip the Investment Thesis!

Many investors have difficulty determining which company shares to buy and when to buy them. I focus on businesses with a strong dividend triangle. This means we are looking at businesses with strong growth vectors for the future, posting consistent earnings growth and with a sustainable dividend growth policy. The stronger the dividend triangle, the stronger the dividend growth policy should be.

When we find such businesses, we dig into their earnings to understand the business model and write down a complete investment thesis. The investment thesis includes both the reasons why we think this company is great and the potential downsides. It’s important to fully understand where the company is going and what could possibly go wrong. Then, and only then do we press the buy button.

3. Watch Your Portfolio and Holdings Weight

Personally, I like when my investments matter. For this reason, I try to keep the number of different holdings between 30 and 40 (for any portfolios over 100K… even if I had $2M+). If I was starting all over again with a 20-50K portfolio, I’d go with 20-25 positions. I would then add more as I grow my portfolio to 100K.

I also like to have equally weighted positions at the start. If you do the math, a “full position” would equal between 2.50% (40 positions) and 3.33% (30) of your portfolio.

In an ideal world, I would pull the trigger for the full amount right away. It’s not proven by any studies but making 1 buy transaction will kill all dilemma and confusion on what to do next. Once I identify my target, I go get it. End of the story. The whole idea of having a clear buy process is to cut the noise, reduce the doubts and improve your conviction level.

If you prefer going with a “half position” and keep the cash for another transaction, you open the door to doubts and analysis by paralysis. You have already done the work once, why bother waiting?

Finally, I like to keep 5%-10% of my holdings for speculative plays. Recently, I bought Brookfield Property Partners (BPY.UN.TO / BPY / BPYU). The position was 3.8% of my portfolio. I don’t have any other speculative plays right now. Those “I’m going to pick a falling knife and make 50%+ in a year” trades could work well… or end-up in a nightmare. Remain cautious at all times!

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