Stocks Tips are not portfolio management

The standard service provided by most brokers, analysts and blogs is stock tips. The analyst typically analyses a company (often superficially) and after declaring it cheap, gives a price target. The brave ones may attach a time frame to the target too. There are several points missing in the above model for a typical investor

– How much of the stock should the investor buy?
– Should the investor buy a full position at the current price or build it over a period of time?
– What is the level of risk of the stock and how does it correlate with the stocks in the portfolio?
– Most importantly, when and under what conditions should the investor buy or sell the stock?
The analyst or the broker involved gets paid for recommending the stock and their responsibility stops at that point. None of the above points are considered when providing the service. In addition, there is sometimes no follow up and review of the stock on an ongoing basis which would help the investor decide whether he or she should buy, hold or sell the stock.

The above missing points in the standard model of the industry are provided at a high price via portfolio management services. I am not aware of the exact pricing, but have been told that it is generally around 2% of the portfolio and some percentage of the gains achieved by the portfolio manager.

This model is ofcourse stacked against the typical investor. The portfolio manager makes money irrespective of whether the investor makes a profit or not.

A decent portfolio management service should have the following features

Stock idea: The service should provide the stock idea with an estimate of fair value and a clear explanation of the risk involved in the stock. I don’t believe that a stock can have only an upside without a downside risk.

Position sizing: The service should provide a recommendation on the position size (amount of stock) and also provide regular inputs if the position has to be built over time.

Correlation risk: There is no diversification if one buy 3 cement and 2 telecom stocks in a portfolio. A lot of times the risk is not as obvious, but should be analyzed when recommending a stock and deciding on the position size

Regular update and sell recommendation: This is sorely missing from the current model. You will rarely find a sell recommendation from an analyst.

I am not aware if the above comprehensive service is available at a decent price. Most of the brokers provide stock tips or similar such recommendations with an eye on generating commissions through buy or sell action of the investor. As a result it is impossible for brokers and analyst to have their incentives aligned with yours.

An example
I discussed my portfolio in this post. I provided a listing of all the stocks in the portfolio with their 2009 gains and also an analysis of the idea in some cases. Does this list give an idea of the portfolio performance ? hardly. Some the ideas in the portfolio were analysed in 2006, some in 2007 and some in 2008. I don’t build a full position at the time of the analysis unless I think that the stock is extremely cheap and there is no point in waiting. The positions were built over the course of time as the stocks got cheaper or the fundamentals improved.

It is important to understand one point – A decision to buy need not be made at the time of analyzing the stock. One should analyse the stock and make a note of it (in my case I have a tracking spreadsheet). If the price drops below a certain threshold, one can start buying or increasing the position. If the price rises, well then move on to something else. It pays to do your homework in advance.

I typically analyse a stock and provide the readers with all the required information to make a decision. However there is still quite a bit of ongoing effort required to track the fundamentals and the price and make buy, hold or sell decisions. These decisions have to be made in context of one’s personal situation.

In my own case, I exited most of my positions in 2006-2007 time frame. I started buying a little bit in mid 2008. My main buying came during Oct 2008 – Jan 2008. As a result I did not hit the precise bottom of the market, which anyway has never been my goal. If the market keeps going up, I will keep exiting my overvalued positions slowly over this year. If however, the market crashes, and I can find undervalued ideas, I will start buying again.

I may have a long term view on stocks, but I am constantly evaluating my ideas on the four factors discussed about and making changes to the portfolio. A long term approach is not a brain dead approach.

The relevant returns
The relevant returns for any portfolio should be for the two year period 2008-2009. Most of the long term investors lost money in 2008 and made it back in 2009. If one has to evaluate the success or failure then one should look at the combined returns for these two years. In my case, I am more than pleased with my returns as I cleared my target by a wide margins (target being to beat the market by 5-8% per annum). I don’t expect to have a repeat performance in 2010.

Conclusion
Building a low risk portfolio and maintaining it, involves quite a bit of effort. If one is not ready to put the effort behind it, then a sensible option is to invest in mutual funds (inspite of all their drawbacks) or in index funds. Stock picks and tips will help you trade and have the thrill of jumping in and out of the market, but if you want to build your networth over a period of time, don’t expect these services to help you on that.