Annual portfolio review – 2010

It’s the time of the year when everyone looks at the year gone by and makes resolutions for the new year. My resolution for the new year? run a 5K marathon :). Anyway, I digress. This blog is not about my attempts to get fit.

I did an annual portfolio review in 2009 here. I think the returns in 2009 were out of the ordinary as the stock markets were recovering from a huge shock. I did not expect the 2010 returns to be any close to it. That prediction turned out to be true.

How I evaluate performance

The most typical approach to evaluate performance is to look at the annual return and if it has met your expectations (which vary from individual to individual), then one can declare victory and move on. As you might suspect I don’t stop at that.

Annual returns are important, but not the sole indicator of performance. A year’s return is driven more by luck than skill. A few lucky picks can give a big boost to your portfolio and a few bad ones can ruin the year. One has to distinguish skill from luck. I look at the portfolio performance for the last 2-3 years and compare it with my objective – which is to beat the index by 5-8% per annum.

Now, there is no audit of my performance, so I can claim whatever I want – no one can verify it. So instead of trying to quote a number, let me state that I have achieved my goals by a wide margin in 2010 and for a 3 year period too

Is 5-8% outperformance not for the wimps?

Now some of you who would have dabbled in small, micro or no cap stocks may be thinking – what a sissy :) . I can do far far better than this dude

My response – that’s absolutely true. My personal goal is not to achieve the highest possible return. My goal is to achieve decent returns at moderate to low risk. My own portfolio has around 15-20 stocks, with no stock more than 5% of the portfolio. I have structured my portfolio to achieve a decent level of outperformance, but ensure that a single bad idea will not ruin my networth.

Think of it this way – A 5-8% outperformance will give me a 19-22% annual return. That means 5-7 times my original capital in 10 years. If I achieve this I will be very pleased with my performance.

Additional parameters of evaluation

I have another parameter which I use to evaluate the attractiveness of my portfolio – let’s call it the ‘discount to fair value for the portfolio’. Let me explain

Let’s say I have two stocks in the portfolio (1 share each)

Stock A – fair value is 100, current price is – 60

Stock B – fair value is 100, current price is – 70

So for total portfolio (A+B) – fair value is 200, sum invested is 130.

The ‘discount to fair value of the portfolio’ is 35% (200-130/200). I generally focus on this number quite closely. This is a very useful number to make buy/ sell decisions and structure the portfolio (more on it in another post)

I am listing the actual discount below for a few years (end of year)

2008- 60%

2009 – 26%

2010 – 36%

The numbers are quite instructive. In 2008, as the market crashed I added stocks to my portfolio and saw this number rise. In 2009 as the stock prices rose, this number reduced (as the portfolio gained in value).

So in 2010, how did this number increase?

Quite simply, I reduced my fully valued positions and kept adding to the undervalued position. Although this is not a magic number, I have seen that if I have done my homework well then a large discount has typically led to a good performance over time.

My overall objective is to keep this number between 30-40% or more.

Specific performance

Let’s get from the abstract to the concrete (hopefully I have not lost you !)

The big winners for me were – Gujarat gas, Merck (finally !), LMW, grindwell Norton (which had not done well last year), Honda siel (surprise), Cheviot (some movement !) , Ashok Leyland etc. I have constantly been selling some of these stocks.

I have added some new positions, some of which are listed here.

I sold off these position or reduced these stocks substantially – NIIT tech, Patni, Infosys, Sulzer, ESAB india, Concor, Denso, VST and Ingersoll rand.

Ofcourse not everything was a winner – VST for one was a very average pick.

The new areas in 2010

I have started exploring several new areas – more from a learning standpoint. I have been experimenting on options and arbitrage.

Options have been a mixed bag and I plan to pursue it more as an insurance than to make money off it. I plan to focus more on arbitrage in the future as it is an interesting field and works well my investment approach.

Plans for 2011

I have no grand strategy for 2011. No hot sectors, must have stocks for next year. The strategy is going to be the same – keep looking for good and cheap stocks the old fashioned way – read and analyse.