Lets say you have a portfolio of around 15 stocks, which I think is sufficient diversification for most of us. Now let’s say, you are one of those odd guys who for some inexplicable reason, believes in long term investing – that is buying high quality companies at decent prices and then holding the stock for the long term.
Let’s assume, for argument sake that the average holding period is around 3 years. In such a scenario, you are buying/ selling 5 stocks per year. Now let’s say, you are able to spend around 5-6 hrs each week on searching for decent ideas and are able to analyze 1-2 companies each week. At this rate, you can analyze 50-60 companies each year.
If you look at the above math, you need to smart or lucky around 10% of the time. I don’t consider that as a high threshold.
What wrong with the above logic?
For starters, the above reasoning assumes that you will be able to find attractive ideas on a regular basis – one every 2-3 months. As most of us who have been investing in the market for sometime know that, these things don’t work on such a smooth schedule. Investing ideas tend to come in clusters and in short periods of time – especially when the short term outlook is clouded.
The other assumption is that one will spend a 5-6 hours a week, diligently looking for stock ideas. Unfortunately, I don’t know of any shortcut to make money in the market. A lot of cheats claim to know ‘techniques’ to make money with minimal effort and are able to find enough fools to sell their techniques.
The logic actually works even better
The above logic works even better than what i claim in the post. Let’s say you are able to indentify some high quality companies such as a titan or crisil and make a purchase at decent valuations. Once you purchase such a company, I don’t see any reason to sell the stock unless the valuations go beyond all reason. In such a case, the portfolio turnover drops still further and the number of new ideas required each year is even lesser.
A 60-70% success rate of your ideas, where 3-4 ideas will either make no money or lose a bit for you is quite reasonable. At this success rate, one will still do well on an aggregate portfolio basis.
If you put it all together, I think one needs to pick a successful idea 5-10% of the time or around 1 in 10 ideas evaluated.
The only downside in the above approach is that you cannot share any exciting stories of your stock market coups with your buddies over a drink.
The comparison with trading
I genuinely believe that trading is much tougher game than long term investing. Even if one leaves aside what is required to be a successful trader, the basic math tends to work against you.
Even if you are a moderately active trader and buy/sell 10-15 stocks a year (1-2 per month), the success rate (no. of ideas invested/no. of ideas looked at) required is much higher than a long term investor. I think one has to be much smarter to be a successful trader than a successful long term investor.
Is that what you do?
Short answer to this question is – Yes. I typically evaluate 2-3 ideas each week in some depth and may end up picking just one idea every few months. In most of the cases, it is either some fundamental issue which turns me off or it may just be that the valuation is not attractive enough.
If the idea is good, but the price is not right, then it goes into my tracking list. I tend to review the tracking list once a month to see if Mr Market is offering some bargain on a decent idea.