Cleaning up the Zoo

My portfolio is now a certified zoo. Although the bulk of my portfolio is in the top 10 holdings, I still hold several stocks which are not as attractive. I initiated a clean up few months back, but it is not as easy as i thought it would be.

How did I get here?
I have always had this problem to a certain extent – call it the teenager syndrome 🙂 – I fall in love with a different girl every month. The problem is that although I fall in love with new girls, sorry stocks, I have refused to let go of the old flames.

Some old flames are worth holding. Companies like asian paints, crisil and Gujarat gas are part of my core portfolio now. They may become overvalued from time to time, but they have phenomenal business models and great competitive advantages. These companies, if bought at the right price, are likely to give great returns over a period of 10 yrs.

The same is not true of several other stocks in my portfolio such as bharat electronics, Honda siel power products or novartis. These are companies with decent economics and fair management. It is just that they are not as attractive, both from a valuation and future performance perspective – call them mediocre stocks (though decent businesses).

I have been too slow in realizing that these stocks, at current prices, will not give great returns going forward.

So what should one do?
The most rational approach would be to sell the stock when it is selling at fair value or when a stock with superior risk reward characteristics is available.

I have usually been able to do that fairly well when the stock is very close to fair value or if I think the economics of the business are no longer attractive (or I have simply made a mistake in understanding it). I have been slow in making a decision on stocks which land in a grey zone. These are stocks selling at a moderate discount to fair value and have average prospects.

An example
Let me illustrate with an example – Bharat electronics. I purchased BEL in 2008-2009 time frame at an average cost of around 850 and have been able to get 100%+ returns in 3 years including dividends.

These returns though decent, are not earth shattering. They are in line with the returns I expected from the company when I invested in it. This company has a near monopoly in the Indian defence market and should keep doing reasonably well in the future.

I personally think that the stock is around 15-20% undervalued and is unlikely to give not more than 12-15% returns per annum over the next few years. These are decent returns, but unlikely to get your heart racing.

The key to such stocks is hold them till the undervaluation corrects itself and then be able to dispassionately analyze the stock and exit , if there are better opportunities available

If you know, why not sell it?
Good question – call it the endowment bias or inertia, but I have been slow to react. It has also been partly due to the issue of opportunity cost.

For most part of 2010 and 2011, I have not invested more than 50% of my net assets with the rest being in cash as I have not found attractive enough opportunities. In such a scenario, a moderately underpriced BEL seems to be a better choice than holding cash. The downside of such a thought process is that soon the portfolio becomes a zoo and one’s mental space (list of stocks being tracked) becomes too crowded.

So whats the plan?
Sell – though it’s not easy to sell and hold cash. In addition, one also faces the risk of regret if the stock which was sold recently, has a run-up after that. Who said investing was easy?

In the end, however to keep my sanity intact and manage a reasonable list of stocks, I plan to bite the bullet and sell these kind of stocks.