Concentrate Your Picks to Reap Big Gains
By Saghir Aslam
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
“Diversify.” It’s the financial industry’s mantra for lowering your investment risk. In reality, it puts your portfolio at risk of mediocre results.
Sure, investing in a dozen stocks can ease the overall damage should one of them tumble and catch you off guard. But the same strategy also greatly lowers the chance of cashing in on a winning stock. In the end, you boost the risk of loosing out on a huge gain even if you do pick a great stock.
Suppose you had $5,000 to invest and you split that evenly among five stocks. All your picks turn out to be winners and rise 5%, 10%, 20%, 50% and 100%. They’d give you a 37% overall return, impressive by most standards. But what if you had chosen just the best two of those stocks? Your narrow portfolio would have jumped 75%. Casting even a slightly wider net can drastically reduce your results.
There’s a better way to manage downside risk than by indiscriminately buying a large basket of stocks. Start with the best stocks in the market. Then put in place an iron-clad rule of limiting you initial losses to 7% or 8% on a single investment. The approach keeps you out of trouble even if only one out of four purchases generates modest gains of 25% or 30%.
Focus your time, energy and money on the best-quality goods on the market. During a bull market, only a fraction of the thousands of stocks out there will double or triple in price. This year is no exception. Only 124 stocks that started the year above $12 a share have at least doubled. These out-performers represent just 1.4% of the more than 8,000 issues.
The first step is to confirm that we’re in a bull market. Then look for the best stock in a leading group. Check its fundamentals: Does it have a product or service that surpasses its rivals? Is the management solid? Is profit growth strong and even accelerating? Are sales growth, after-tax profit margins and return on equity also high? Usually, only one or two companies in a group can meet all of these requirements.
Check a stocks’ technicals. Is it carving out a bullish chart pattern? What do institutional investors-the main movers of the market-thinks about the stock?
Finally, there’s the task of timing your buy. As outlined in recent columns, you want to buy at the moment a stock breaks out of a base.
It’s a lot of work to find and buy a leading stock. Can you really put in all the effort necessary to assemble a portfolio of 25 or 30 stocks?
As a rule of thumb, own no more than two stocks if you want to invest $5,000 in the market. With $10,000, two or three stocks is appropriate, and with $25,000, three or four.
Review your stocks at least once a quarter. For best results, you should review it monthly. Check and see if it is performing up to your expectations. Are all of your fundaments still in tact? Once again, set up your plans. Follow your plans. Stick with it and you will find that with the proper discipline you will InshAllah reach great rewards. Which performed the best? Are the earnings still looking good? What’s happening in the various industry groups? Prune the laggards from your portfolio and shift the money into emerging leaders.
If you’ve got a stock that’s turning into a big winner, you might try to buy more shares at appropriate times. Add to your position after the stock corrects and breaks out of a new, well-formed base. Or you might pick up a few shares when the stock pulls back and finds support at a long-term trend line or moving average.
The goal is to concentrate, not diversify. It’s better to master a few, well-chosen stocks than be at the mercy of a crowd of average investments.
You must decide if you want to go with this strategy or go with the advise of earlier articles to diversify, diversify, diversify. You must decide what you plan is. It is either that you concentrate on a few stocks or diversify. But you still must follow your stocks closely. Get out of the losers early. Stick with you winners. But most importantly you must not deviate from your plan and InshAllah you will reap great rewards.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr. Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, or does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr. Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr. Aslam does not have anything for sale.)
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