The standard service provided by most brokers, analysts and blogs is stock tips. The analyst typically analyses a company (often superficially) and after declaring it cheap, gives a price target. The brave ones may attach a time frame to the target too. There are several points missing in the above model for a typical investor

– How much of the stock should the investor buy?
– Should the investor buy a full position at the current price or build it over a period of time?
– What is the level of risk of the stock and how does it correlate with the stocks in the portfolio?
– Most importantly, when and under what conditions should the investor buy or sell the stock?
The analyst or the broker involved gets paid for recommending the stock and their responsibility stops at that point. None of the above points are considered when providing the service. In addition, there is sometimes no follow up and review of the stock on an ongoing basis which would help the investor decide whether he or she should buy, hold or sell the stock.

The above missing points in the standard model of the industry are provided at a high price via portfolio management services. I am not aware of the exact pricing, but have been told that it is generally around 2% of the portfolio and some percentage of the gains achieved by the portfolio manager.

This model is ofcourse stacked against the typical investor. The portfolio manager makes money irrespective of whether the investor makes a profit or not.

A decent portfolio management service should have the following features

Stock idea: The service should provide the stock idea with an estimate of fair value and a clear explanation of the risk involved in the stock. I don’t believe that a stock can have only an upside without a downside risk.

Position sizing: The service should provide a recommendation on the position size (amount of stock) and also provide regular inputs if the position has to be built over time.

Correlation risk: There is no diversification if one buy 3 cement and 2 telecom stocks in a portfolio. A lot of times the risk is not as obvious, but should be analyzed when recommending a stock and deciding on the position size

Regular update and sell recommendation: This is sorely missing from the current model. You will rarely find a sell recommendation from an analyst.

I am not aware if the above comprehensive service is available at a decent price. Most of the brokers provide stock tips or similar such recommendations with an eye on generating commissions through buy or sell action of the investor. As a result it is impossible for brokers and analyst to have their incentives aligned with yours.

An example
I discussed my portfolio in this post. I provided a listing of all the stocks in the portfolio with their 2009 gains and also an analysis of the idea in some cases. Does this list give an idea of the portfolio performance ? hardly. Some the ideas in the portfolio were analysed in 2006, some in 2007 and some in 2008. I don’t build a full position at the time of the analysis unless I think that the stock is extremely cheap and there is no point in waiting. The positions were built over the course of time as the stocks got cheaper or the fundamentals improved.

It is important to understand one point – A decision to buy need not be made at the time of analyzing the stock. One should analyse the stock and make a note of it (in my case I have a tracking spreadsheet). If the price drops below a certain threshold, one can start buying or increasing the position. If the price rises, well then move on to something else. It pays to do your homework in advance.

I typically analyse a stock and provide the readers with all the required information to make a decision. However there is still quite a bit of ongoing effort required to track the fundamentals and the price and make buy, hold or sell decisions. These decisions have to be made in context of one’s personal situation.

In my own case, I exited most of my positions in 2006-2007 time frame. I started buying a little bit in mid 2008. My main buying came during Oct 2008 – Jan 2008. As a result I did not hit the precise bottom of the market, which anyway has never been my goal. If the market keeps going up, I will keep exiting my overvalued positions slowly over this year. If however, the market crashes, and I can find undervalued ideas, I will start buying again.

I may have a long term view on stocks, but I am constantly evaluating my ideas on the four factors discussed about and making changes to the portfolio. A long term approach is not a brain dead approach.

The relevant returns
The relevant returns for any portfolio should be for the two year period 2008-2009. Most of the long term investors lost money in 2008 and made it back in 2009. If one has to evaluate the success or failure then one should look at the combined returns for these two years. In my case, I am more than pleased with my returns as I cleared my target by a wide margins (target being to beat the market by 5-8% per annum). I don’t expect to have a repeat performance in 2010.

Conclusion
Building a low risk portfolio and maintaining it, involves quite a bit of effort. If one is not ready to put the effort behind it, then a sensible option is to invest in mutual funds (inspite of all their drawbacks) or in index funds. Stock picks and tips will help you trade and have the thrill of jumping in and out of the market, but if you want to build your networth over a period of time, don’t expect these services to help you on that.

I usually review my portfolio towards the end of the year and try to figure out what went right and where I goofed up. I disclosed my portfolio last year and the portfolio has remained more or less the same since then. I sold off some small positions such as India nippon, manugraph etc and have added to other ideas such as LMW, Ashok Leyland and other existing ideas, which I felt were cheap during the course of 2009. So how did it all turn out? well far better than I expected at the beginning of 2009. A summary of the results follows

So what grade do it get ?

I have given myself a B for picking stocks and a B+ for having the patience and confidence in buying and holding the picks during the terrible drop in the markets. The stock picks are not phenomenal picks in themselves. It was very easy to find undervalued stocks during the Oct 2008 – Mar 2009, but difficult to buy and hold them. As an analogy with cricket, my picks are like singles and doubles, occasional fours and a very rare six. I am unlikely to lose my wicket on a reckless shot, but watching me play would kill one with boredom 🙂

Reviewing the picks

A few picks standout in the above list – namely Merck, CRISIL, Grindwell Norton and Honda siel. ESAB india and sulzer don’t count as they are fairly recent picks. These picks have done poorer than the index and hence are worthy of deeper attention.
I have written about merck earlier here. I still feel it is undervalued and plan to hold on to it. The main reason for the underperformance is that the fundamentals of the company have not improved as expected over the years and hence the stock market has not given it a decent valuation.

CRISIL has performed as expected. The company was not as undervalued as some other stocks last year and hence the gain has not been as high. Grindwell Norton and Honda siel have not perform as well as some of the other companies and hence the stock performance has not been as good as the index.

A few other picks such India Nippon, Manugraph were clear goofups bought during the bull market and exiting them was a necessary decision. I don’t expect to have a 100% success rate in picking stocks and it should still work out fine as long as my mistakes are smaller than my successes. For the time being, that has been so.

Is an annual review sensible

I have continuously harped on the need to have a long term view. Is it sensible to evaluate a portfolio on an annual basis ?

I personally think that any outperformance or underperformance over a year is usually a matter of luck. However it still does not mean that one should not evaluate the picks atleast once a year and see what worked and what didn’t

Conclusion

My conclusions for the year has been as follows

• Majority of the returns for the year have happened as the market corrected the undervaluation of midcaps. This is unlikely to happen in 2010 as there are not as many undervalued stocks out there.
  
• It is important to understand the difference between a cyclical drop in demand and permanent change in industry dynamics. 2008-2009 was a cyclical drop for several industries such as auto. The same is however not true for telecom which is undergoing a structural change.
  
• It is important to bet big when the odds are in favor (price is low). It is also important to ignore the chatter in the media which is as best a distraction.
  
• I was lucky in 2009. I don’t expect to be as lucky in 2010 and will have to work harder to get decent returns.

So whats next ?

I really don’t have a crystal ball for 2010. I have no clue whether the market will go up or down. My approach has remained the same for the last 10 years and will be the same in 2010 – buy when the stock is undervalued and sell at intrinsic value or higher – market forecasts be dammed.

That said, I expect it to be more difficult to generate good returns in 2010 and beat the market.

Final note : The above listing is not entirely indicative of my returns as all the holdings are not equal weighted in the portfolio. Some holdings such as LMW and ashok Leyland have a higher wieghtage than the others.

As I read somewhere – its better to be lucky than smart. Well, 2009 was a very lucky year.