Approximately a year and a half back a
few of us fund manager friends were sitting around discussing our portfolios
over tea, of which I wanted to highlight a particular interaction. We happened
to talk about the software sector and one of us remarked upon my portfolio
namely the extra-large holding of a stock we can call “I”. One top performing
fund manager immediately compared it to other large capitalisation stocks in
the sector, saying it was a non-performer for many years and that the
management had no clue what it was doing. He further added it was preferable to
buy a stock; we shall call “T” as its management was more aggressive and seemed
to know what it was doing. After trying to explain, on his insisting of the
rightness of his point, I kept my silence.
Forward to today the stock “I” has
become the new darling of the market having returned almost 50% in the time
period, while the stock “T” returned approximately 12%. The point I am making
is, at a price, risk is minimal in a stock. A particular stock may also do
better than another in the short term purely because it has a higher risk model
which is currently delivering growth, but such growth may be at high risk, as
we have seen with the US FDA notices to many popular Indian pharmaceutical
companies. What makes you money is not whether the company is good, bad or
ugly, but whether the price you buy it at, gives you a margin of safety,
considering the present business model and its risk. Therefore exposing your
portfolio to unnecessary risks in pursuit of returns, will most likely not
deliver reasonable returns in a 5 to 7 year horizon.
Dinesh da Costa, CFA
Please note the information given above is not a recommendation to invest, but an educational illustration.
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