Use access key #2 to skip to page content.

Random Thoughts and Strategy



March 13, 2010 – Comments (17)

After my previous post detailing my general approach to investing, I found that I didn't really have much to say for a while.  As a relatively inexperienced investor, I'm still learning quite a lot.  I decided to highlight a couple decisions that come into play when putting together and maintaining a portfolio. 

Concentration vs. Diversification

As with most things, there's really no catch-all statement or rule that works.  Should you concentrate or diversify? It depends.  

I generally believe it's best to concentrate.  If you have 5-10 best ideas, you should put all of your money into your best ideas. This works quite well when you are invested in mid or large caps, companies with market caps of $2B or much more.  Large caps are preferred, but I wouldn't mind putting my money into 5-10 high-quality mid caps that I've researched thoroughly.

However, I'm still most interested in micro caps.  This presents a bit of a problem, because I think it'd be too risky to put all your money into just 5-10 micros.  Instead, I'd put together 20+ companies if possible.  The micro cap space has many more companies, so this shouldn't be too big a problem.  

To summarize: concentrate with larger companies, but diversify with smaller ones.

Share Buybacks

This portion is inspired by this post by danielthebear. 

In my opinion, the perfect company would obviously maintain a strong balance sheet in good times and in bad.  Due to irrationality, every company's stock price is too low at times and too high at other times.  If I owned a company, I would want that company to buy back shares at lows with that cash. At highs, I would want this company to issue shares if it could put it to use wisely.  If not, I would not want any buybacks at all.

I've seen that buybacks are handled incorrectly by a whole lot of companies.   Due to stock options associated with ridiculous executive pay packages, companies often buy back shares whether or not they're undervalued.  This is obviously not good for shareholders.

I've also seen situations in which companies announce buybacks just to keep the stock price high.  This is often done without regard for how undervalued a stock is.  I've also seen that not all companies follow through with said buybacks.  This can obviously be a red flag because it means management is dishonest.

In a nutshell, I put no stock in share buybacks.  When doing research, I believe you can pretty much ignore buybacks.  It's done incorrectly so often that you could ignore this aspect and still do extremely well in your valuations.  I do, however, take notice when there is dilution.  Watering down the stock is something I absolutely dislike.

Personal Finance

I'm 26.  I still carry various debts, including student loans.  I have just a small emergency fund and I work in the steel industry.  Trust me, we're not doing so well in the steel industry.  Anyway, before I became so interested in stocks, I was big on personal finance.  I think it's more important to manage your debts and cash flow before attempting to compound your money through investments such as stocks and real estate.

Stocks were so cheap at times in 2009 that I couldn't resist putting whatever free cash I had into the market.  In fact, I took out credit card balance transfers to get extra cash into the market.  I did this in late Jan 2009, and have since paid the balances with profits from stocks.  I know it was risky, but I would do it again given the stock prices from late February and early March, when I was buying with that cash.

While it worked out quite well for me, I've changed my stance in 2010.  Now that the market has settled down and the irresistible bargains have just turned into decent ones, I'm being a lot more careful with my cash.  I've decided one of the biggest priorities in the near future is to establish a larger emergency fund.  I used to tell myself that I could pour all of my money into stocks and have that double as an emergency fund, provided the account balance was way higher than the size of emergency fund I'd like.

This didn't work so well, because having my "emergency fund" at risk didn't sit well with me, even if it could sustain a big loss and still have enough cash to cover many emergencies.  I know you've all heard it over and over, but I must reiterate this: if you might need the cash in 3-5 years, it should not be at risk.  Put it in high-yield savings, a CD, or some other riskless investment.  

In short, get your own personal finances in order before putting money into the market.  The crash of 2008/2009 will NOT be the only market crash.  I expect to see many more in the future.  I'd rather get my personal finances cleaned up completely so that next time, I will be putting money at risk that I could completely afford to lose.

Chinese Micro Caps

I've covered why I think you should diversify with micro caps.  My various accounts hold mostly micros and cash.  I do own quite a lot of Chinese micros, so I think a little discussion is warranted.  There's been a lot of fuss about a possible bubble in China.  All I have to say is this: Chinese micros often have trade at larger discounts, and I believe it's justified.  When buying Chinese micros, I would demand better numbers than I would from a US company. 

Government regulations and such play a large part in China.  Some companies are privileged to be the only companies allowed to issue certain services or goods.  At any point in time, the game can change drastically.  It likely won't, but one should exercise caution.  

With Chinese micros, basically:
1. Demand better numbers to justify purchases
2. Diversification is very important

Closing Thoughts

I look forward to comments and such.  I've enjoyed the long discussions following my blogs, and I'd appreciate any discussion on the above points.  

17 Comments – Post Your Own

#1) On March 13, 2010 at 8:09 PM, Tastylunch (28.76) wrote:

-I generally believe it's best to concentrate.  If you have 5-10 best ideas, you should put all of your money into your best ideas.

Concentrations is essentially like leverage if you ask me bullishbabo. And Diversification is basically a hedge against lack of knowledge/shill and the unknown.

So they have their uses.

Ideally of course concentrating can increase your wealth very quickly, which is it's allure but it can also whip right back on you. The biggest successful concentrator I've ever heard of is Dan Zanger who would go long 200% in one position.  He went from building pools to hedge fund manager in one year doing that. but it was 1999 and that was a very special year.

I'll admit concentration worked unusually well in 2009 similiar to 1999. A huge % of stock went into bull mode. I suspect that will much tougher to do going forward as the market reaches more a traditional lower volatility and more sideways action.

A recent example of this is recent hotshot value investor Mohnish Pabrai he of famed lunch with warren buffett fame. He used to be a 10/10 (10 positions 10% each) guy and just killed it from 2002-2007. I think he had annual returns in excess of 25% or so.

But 2008 he had massive losses and lost from what I recall 50% of funds under management. And he was/is considered a rockstar value investor. Not coincidentally he had a great 2009 again, although he abandoned his 10/10 philosophy for a more tiered sturcture.

On the inverse you have Walter Schloss another student of Ben Graham like Buffett, he rarely ever had less than 100 positions at any one time and he had a CAGR of 16%+ over 50 years with remarkably little volatility.

So I don't know if concentration is necessarily better and I don;t knwo if diversification is necessarily "diworsefication". Depends on personal taste, market environment and skill (risk managment and Due diligence) from what I can tell.

 I personally try to use tiered exposure more or less the way pabrai does now. In practice I don't think I've ever gone larger than 8% TP into any one long position and rarely go much above 5%

Not really hard and fast rules I guess.

Report this comment
#2) On March 13, 2010 at 8:11 PM, greenwave3 (< 20) wrote:

Nice post. I agree with your sentiments about concentration and diversification. I think that holding more than one concentration cluster and filling in the gaps with undervalued or quick-growing small/micro caps is a good way to go.

Several months ago, I was riding several Chinese small and micro caps up with the market, such as WUHN, CSR, FEED, CNGL, JST, etc. I have since exited all the aforementioned positions, although I am still long on HOGS, which I have owned for a while.

China worries me a bit right now because of their growing housing bubble and likely appreciation of their currency. I believe that owning U.S. companies with significant sales and operations in China are a better play going forward so you can take advantage of the U.S. currency/export advantage.

good luck


Report this comment
#3) On March 13, 2010 at 9:25 PM, Bays (29.11) wrote:


I feel as though we have the same reading material on our bookshelves. 

I agree 100% about stock buy-backs.  For example, Oracle, back in 2000 issued stock to inseders at an average of $3.50 per share and repurchased it at an average price of $18.26.  Like you said, its done incorrectly the majority of the time. 

As for concentration over diversification, I prefer the former when it comes to stock picking as I leave the diversifying to investing in index funds.  I have a 75/25 split for my portfolio.  Seventy-five percent stocks, and 25% Canadian bonds.  Within the 75%, 90% comprises of index funds, while the remaining 10% are stocks I pick myself.  This gives me a lot more time to put my energy in a few stocks I feel are the most undervalued. 

As for the 75/25 split, when the market crashes and the 75 becomes 55, it forces me to sell bonds and buy stocks at cheaper prices.  It works the other way as well -- as the market becomes irrationaly high, I will take profits and out them into safer investments.

Everyone has their own strategy, for me, this is what helps me sleep at night. Report this comment
#4) On March 13, 2010 at 9:50 PM, dragonLZ (70.08) wrote:

Very smart approach, Bays.

Good Luck All!

Report this comment
#5) On March 13, 2010 at 10:05 PM, Bays (29.11) wrote:

Merci, mon ami.


Report this comment
#6) On March 13, 2010 at 10:36 PM, rd80 (96.82) wrote:

I think it's more important to manage your debts and cash flow before attempting to compound your money through investments such as stocks and real estate.

Wise words.  Paying down debt is often the best investment available.  Example - Paying down credit cards or a car loan is effectively a risk-free, tax-free return at the loan interest rate.

Report this comment
#7) On March 14, 2010 at 4:24 AM, TMFBabo (100.00) wrote:

@Tasty: Yeah, it's probably just best to go with what you're comfortable with.  I do believe, however, that concentration would work if you did it Phil Fisher style.  Following that man's rules would take forever, but I'm 100% sure that you would do extremely well.

@wave: Glad to hear you exited FEED.  I liked FEED when it was $1.00, but I think it lost all semblance of cheapness as it soared past $3.00 and $4.00.  When it was above $6.00, I was wondering why people were still bullish on it.  As of right now, I believe HOGS is indeed the superior stock to own.

I like the "US companies expanding to China" idea.  I would feel safer with them just because I'm more certain of their legitimacy just because they're based in the US. 

@Bays: I do remember we've agreed on investing views before as well.  "Whatever helps you sleep at night" is excellent advice.  If something makes you worry, you should get rid of whatever's worrying you.

I like how you shift the money to bonds as things get less undervalued and shift it back to stocks after they become very undervalued.  I prefer to actively manage a much higher portion of my own portfolio, but I obviously have small account balances after just several years as a working professional.

@rd80: I often hold stocks less than a year, so I'm finding that paying down debts is that much better in comparison.  Assuming 30% short-term capital gains (ie income tax), a 7% debt reduction is like earning 10% on an investment.  That makes the debt repayment that much sweeter for me.

I think I can beat 10% long-term (otherwise I shouldn't be trying), but I still make sure a portion of my money goes towards debt reduction because I just can't help but pay some of it off.

Report this comment
#8) On March 14, 2010 at 10:56 AM, rhallbick (96.82) wrote:

I've seen that buybacks are handled incorrectly by a whole lot of companies.

Ditto on BAYS comment.  IMHO most companies only use share buy-backs to increase the value of employee stock options.  It is just another form of price manipulation by those seeking to sell.  So, they are handled incorrectly from the point of view of investors and are handled correctly from the viewpoint of management.

Report this comment
#9) On March 14, 2010 at 4:14 PM, gartersnk (62.46) wrote:

Good post.  If you have money on a credit card - carrying a balance - from 15 to 25% - or even if it is a low rate - you make that rate of return by getting rid of the debt. Glad to see there are some young people out there who have a clue. I'm in a debt free situation, with a decent cushion of savings, and now working on building a retirement package. Timing is important both in the market and in life.

Regarding diversification versus concentration, it also depends on the investors age - I'm 50+ and have had to start over not long ago due to bad choices including a divorce - my strategy is obviously going to be different than yours.  You said it well regarding concentration in large caps and diversification in small.  I look at it as low risk core holdings, in my case large companies with safe income potential and a diversified array of small and micros with higher risk but more potential reward. In the end it also boils down to what can you sleep at night with - as stress will kill you faster than a market crash LOL 

Report this comment
#10) On March 16, 2010 at 12:05 PM, zCreator (95.08) wrote:


I'm finding it very hard to know when to sell. How do you know when to end a pick?

Report this comment
#11) On March 17, 2010 at 6:40 AM, TMFBabo (100.00) wrote:

@rhallbick: I agree.  Most managements don't seem to think of the shareholders first.  I guess this is one aspect where insider ownership is important.

@gartersnk: Glad to hear you're debt free; I'm hoping to get there in 5-10 years.  I've read too many personal finance blogs where people comment like this: "I"m 55 and I have $50k in cc debt and meager savings! How do I fix this?"

You might be surprised to hear that I have tremendous respect for quality dividend growing large caps such as PG, JNJ, CLX, and more.  Even though I proclaim myself a micro cap investor all the time, I'm still tempted by those stocks almost everyday.  That's exactly the type of stock I'll be buying when I'm closer to retirement: the type that you can just buy and almost forget about.

@zCreator: I think it depends on why you bought it.  There are times (like the past 2 days) when a stock like AOB drops 15% or more on increasing year-over-year quarterly earnings because they missed analysts' earnings by a few cents.  This is asinine, so I bought shares of AOB between $4.10 and $4.19 with the intent of selling after a 10% to 15% gain.  I don't like AOB so much as a long-term holding due to management's overly dilutive ways, but I like it as a short-term play, the type that earnings season provides.

Other times, you might buy because you think a stock is worth $20 to $25 and you see it for $12.  In this case, you might sell at $20 to $25, unless the company has made strides in that time to increase sales and earnings at a decent clip in the future as well.  However, if a stock reaches fair value (as determined by myself) and I'm watching other stocks that are much more undervalued in comparison, I will often switch the two holdings.  Not everyone agrees with me on that one, but I do that personally.

Not all of my stocks are bought because they're amazing long-term holdings.  I actually think it's more fun to take advantage of ridiculous sell-offs like AOB's quarterly profit increase leading to a 15% drop.  I maintain a large watch list and try to see when earnings dates are for each stock, so that I can buy on a ridiculous double digit dip for a short-term gain.  There are similar dips on non-earnings days too, so I look for these as well.

There are more situations, but it really depends on why you've bought.  I hope this helps!

Report this comment
#12) On March 17, 2010 at 12:35 PM, Griffin416 (99.97) wrote:

Nice post. Paying down debt (except for your mortgage if applicable) is first, then make sure you have healthcare, then make sure you have an emergency fund, then create a discretionary portfolio. All investors/ traders should know this first.

Like you, I admit I went berzerk at the bottom and shoved half my money in the TNA, but sadly took it out a week later for fear of my money/ sanity. But thankfully, I realized it was the real thing by mid-April and shoved all my cash in. Simply buying MDY and buying more on any dip can beat the market substantially. Mid-caps have outperformed both large and small caps in bull and bear markets and over the long term.

To answer the question above, "know thyself" is the most important way to invest. As shown by my caps percentage, I am very accurate and even more so in real life, the problem (nobody is perfect) is when I get it wrong, oh boy, I get creamed. So for me, I need much more diversity because I can not afford to lose 10% of my money on a bad bet.

Since you mentioned it above, AOB gave my the smackdown.

Happy investing,


Report this comment
#13) On March 17, 2010 at 1:41 PM, Newmanium79 (< 20) wrote:


 I like to see posts like this, please keep them coming.  I too an a beginner investor and I'm looking for some advice from a straight-shooter and someone who has been in my position before, but won't talk to me like I'm a 4-yr old.  What books should I be reading (exlcuding Graham's two books you mentioned in your other post) or sites I should visit on a frequent basis (outside of  I check marketwatch, cnbc, minyanville, but I never really get any good advice from those sites.  I really need to start from the beginning and learn how to evaluate companies at a more in-depth level.  Can anyone guide me in the right direction to start?


I invest in mutual funds in my 401k and IRA and have a few stocks, but those purchases weren't made on fundamental or technical analysis.  They were made because I use the products a lot that these companies make.  I'm finding a hard time finding winners that I have conviction in.  It's time for me to get serious!

Report this comment
#14) On March 17, 2010 at 1:52 PM, Griffin416 (99.97) wrote:

Newmanium79 ,

For long term money...the heck with mutual funds. The SPY beats 60% of them plus it has lower fees. The MDY beats the SPY almost all of the time (as stated above), by keeping 10-20% cash and using that to buy on dips and crashes you are even further ahead of the game. Provided the market in general goes higher over time, you will beat 80% of participants with that alone. The should also be some allocation to foreign stocks (EEM) and some high yielders, such as BP, MO, etc.

The Cramer book, Real money is great for trading and cyclical investing. Buy a Buffett book to understand fundamental analysis much better. For technical analysis, this is more difficult, but has some really good stuff. for current charts is free also and great.

I have been in the game for 14 years and quite experienced, but for beginners, buying the MDY and a few other index ETF's are great until you really learn the ropes and stray away slowly as you get more confident. One great way is to paper trade, like this CAPS system lets you do.

Report this comment
#15) On March 17, 2010 at 8:44 PM, MKArch (99.81) wrote:

26 years old, top of CAPS in a construction industry related field and it looks like you are a Phillies Phan. Welcome to my favorites bullishbabo!

Report this comment
#16) On March 21, 2010 at 6:16 PM, TMFBabo (100.00) wrote:

@Griffin416: Yeah, March was pretty unbelievable.  I'll have to look into MDY to see what the fuss is about.  I prefer to invest in individual stocks, but I don't usually recommend individual stocks to people I know, since they don't do their own research. 

I like AOB's numbers a lot, but I can't get myself to do anything more than roller coaster it. 

@Newmanium79: Here is an early post I did with a good starting points for books.  Most of the useful information I've found has been from books and investing my own money, NOT various investing sites as many would think.  

@MKArch: It's going to be a good year.  I would've liked Halladay AND Lee, but I'll gladly take Halladay as an upgrade over Lee.  Not many pitchers can shut down the Yankees with decent regularity like that guy can.  

Report this comment
#17) On April 06, 2010 at 1:24 PM, Newmanium79 (< 20) wrote:

Halladay was a beast yesterday!  Actually the whole team was firing on all cylinders.  It's going to be another great year for the phils!

Thanks for the link!

Report this comment

Featured Broker Partners