My earlier tendency when adding a stock to my portfolio was to allocate an arbitrary amount of money to it. The actual bet or the size of the position was initially a fixed amount of money and later it became a fixed percentage of the portfolio (around 5 % usually).
However later I read several articles and charlie munger’s thoughts on investing and have modified my approach. After I have identifed a stock and am willing to commit money to it, I try to evaluate how confident I am about the stock. I try to quantify this confidence level in terms of the margin of safety, which is the discount at which the stock is selling from the intrinsic value of the stock. So if the intrinsic value of the stock (as calculated by me) is 100, and if the stock is selling at 60, then the discount is 40%. So higher the discount or margin of safety, higher my confidence.
In addition, I try to calculate the odds on the stock too. I use the following formulae to calculate the odds
Intrinsic value (under most optimisitic assumptions of growth, profit margins etc) – current price / (current price – intrinsic value (under most pessimistic conditions)
So my cut off in terms of odds is 3:1 and I typically look at stocks selling at a discount of 40% to intrinsic value. The above may seem to be very stringent criteria in terms of selecting stocks, especially under current market conditions. But this criteria has served me well, as I am able to build a huge margin of safety in my purchases. Ofcourse I am using the above criteria for my long term holdings.
My bet or size of the position is generally 2% or 5 % and a max of 10% if my level of confidence is very high. However I am not into portfolio balancing. So if my best idea has done well and is now say 20% of my portfolio and I think is still undervalued, I let it run and remain in the portfolio. The only time I would sell would be if the fundamentals of the company deteriorate or the company becomes highly over valued.
Side note : Just read that capital account convertibility may be introduced in india. That could have major implications for all of us as investors as it is possible that we may be allowed to invest out of india. I think currently we can do that with a limit of 25000 usd, but it is with restrictions. Lets see what kind of freedom the capital account convertibility brings in. I am however optimistic and excited about it.