Your portfolio is about preserving capital in the short-term and achieving capital appreciation in the long-term. In addition to this, you might seek to produce some level of income but these goals can often feel complicated and obscure to achieve. So how do I go about it?
When pursuing these goals, I find looking at the stocks in my portfolio as if I am the sole business owner is helpful. As a shareholder I am a partial owner and that fact provides a useful framework for determining when to buy, when to top up and when to sell positions in my portfolio.
For example, let’s assume I own a factory which I bought for £150,000 in 1990. Unfortunately, after nearly 30 years of strong returns the facility stops performing as expected. I used to enjoy increasing revenue but suddenly my customers are moving to competitors and demand for my products is drying up. One of my managers approaches me with a strategic analysis that indicates we need to move to new products and make structural changes to the way the plant works to reduce our costs and bring prices down – a plan which I duly endorse.
After 18 months, this plan is clearly not working, so I fire the manager and hire a new one. He approaches me with a different plan, which I endorse, but now the situation is worse. Instead of the meaningful profit we were making 18 months before, we’re now barely making anything and are struggling to stay cash flow positive.
Sure enough, after another 18 months, the second manager has failed to make a meaningful impact to the business, and instead of the profit we were generating three years before, we’re now losing money every month. I fire the second manager and hire a third – who has his OWN brilliant plan for turning things around.
Throughout this process, a local property developer has been contacting me in an attempt to buy my factory and redevelop it into luxury accommodation. The property is located in a great location with fantastic views and the developer was happy to pay me 85% of the price I paid for the factory but over time he’s become less enamored with it and now only wants to pay 50% of the price he originally offered.
At the same time, I’ve been examining a factory on the other side of town which is profitable and growing – but I’ve decided to stick with my own facility. At some point though, it becomes obvious that I should sell it and move on.
It should be obvious but this factory is your share of a business. The competing factory is another share and the property developer is a buyer of your share who you can contact through the stock exchange. If you’re holding a position in a company that’s undergoing a ‘restructuring’ or ‘turnaround’ you have to be honest about the impact that the programme is having on the underlying company.
I see so many management boards present shareholders with overly optimistic and vague plans during times of stress, ignoring debt on the balance and collapsing fundamentals. Once a single issue is found by the market, more usually follow. Failing companies usually have rising debt, falling revenues, fierce competition and slim profit margins – and they usually have management teams that focus on fluffy ‘culture’ statements and ‘strategic plans’ than hard metrics, by which I mean cash coming in the door, profit margins, and return on investment.
When examining whether to buy, hold, or sell a position, I pretend I own the whole business. I go back in time and look at how it has performed historically, I look at the competitors to see how they’re performing, and I consider what alternatives I might be open to me and how these compare to the option I’m exploring.
I usually find this process helps me to avoid making snap decisions or becoming overly emotional about a share – although I have brand names I really like, my main goal is always preserving capital in the short-term and achieving capital appreciation in the long-term with a healthy dose of income thrown in for good measure.