GOLDEN INVESTING RULES
In nearly 40 years on Wall Street, the late
Louis Ehrenkrantz, dean of American stock pickers, was known for his ability to
predict social and political developments — and identify companies that would
benefit most from those events.
First rule: develop a large appetite for
reading; it will hone your instincts for finding successful companies.Second
rule: don’t overdiversify; ten stocks, in at least three sectors, are
enough for the average investor.Third rule: stick with your winners and sell
your losers; do not automatically sell when a stock hits a target price, but
continue to hold it as long as it performs well and has good prospects for the
future.Fourth rule: look for top-quality, out-of-favor companies; look for
companies that produce an array of high-quality products and/or services.Fifth
rule: don’t worry about earnings if a company makes a popular product; strong
earnings growth will follow.Sixth rule: don’t tinker with your portfolio; check
your portfolio’s performance only once or twice a year.Seventh rule: don’t be
afraid to hold cash; it’s okay to be prepared to purchase stocks with
beaten-down prices after a correction.
The great Ehrenkrantz’s rules were
published in a recent Bottom Line.
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UPDATE: August 16, 2005 7:01pm
A reader informs me that Mr. Ehrenkrantz passed away 6 years ago in 1999, and is no longer affiliated with the firm that still bears his name . . .
Does the third rule and sixth rule conflict? If you only adjust your portfolio twice a year how are you supposed to get out of a clearly damaged stock a la KKD?
I had more trouble with #2. Unless you’re telling
individual investors to stock-pick only as an
overlay strategy, that one invites them to make
implicit and unconscious bets.
I am not a reflexive indexer, but I find that if
you have no opinion, you shouldn’t make the bet.
Ten stocks in three sectors is an awfully big bet
against everything you happen not to hold.
While i can appreciate you referencing Louis Ehrenkrantz’ Golden Rules, please be aware that
1. Mr. Ehrenkrantz passed away before the Millenium, sometime in August 1999.
2. The Bottom Line article was written post-millenium, as an homage to Mr. E., sometime between his death and the millenium.
Quite a dated reference, yet still accurate.
http://www.investmentreview.com/archives/1999/fall/diversification0.html
The # of stocks one needs to own to reduce company-specific risk is debatable. Based on a corp fin text book and class, my initial thinking was that it was around 20 stocks or so. Brealey Meyers Principles of Corporate Finance (7th Edition) has a graph based on the M. Statman, “How Many Stocks Make a Diversified Portfolio?” (Journal of Financial and Quantitative Analysis 22 (September 1987). The graph ends at 20 stocks on the x axis. Some think it is more – some less.
In defense of the suggestion of 10 stocks: the amount of company-specific risk an investor eliminates by owning stock in 10 companies (vs. owning stock in 1 company) is a lot more than the risk eliminated by owning shares in 20 companies (vs. 10 companies). In other words, there are diminishing returns to risk management through buying shares in additional companies.
If you try hard you mostly can diversify away unwanted stock-specific risk with ten holdings. Some relative risk, of course, is desired — otherwise you’d just buy VTI for 7 basis points and be happy. What bugged me were the sectors. You cannot be in only three sectors and not take on pretty heady and probably unwanted tracking error.
As an overlay on top of a cheap index portfolio, of course, ten stocks and three sectors are more than sufficient.
Check out this article ‘The 4 Timeless Rules of Investing‘. #1 rule for me over the years, ‘Buy an investment when it has few friends’.