Chapter 4: Process or How the heck do I Invest in Equity Successfully?

4.7 Build a Wealth-creating Portfolio

How do you build a portfolio that will deliver high compounding returns but keep risk at a manageable level? Do companies perform differently in different economic and market cycles? How can you use this to build your portfolio? How do you set your criteria to identify opportunities to do this effectively over time? What is required to build a large-size  portfolio  with confidence? 
Quality-at-Reasonable-Price is the Investing Process that we recommend is most suitable for retail investors and all DIY investors and you have seen the reasons why. You have also seen how to answer the 3 essential questions before you invest in a stock. Now, how do you build your portfolio using all that you have learnt, because the asset that is going to take you to your goal of financial freedom is your portfolio, more specifically you equity portfolio.  

Choosing the First Gate in the Opportunity Management System

The first gate is about selecting the universe of stocks you are interested in. There are 5000+ listed stocks and all you need is 25 to 30 in your portfolio. The first gate serves a different purpose from the subsequent QVPT-Quality, Valuation and Price Trend gates and this is critical to building your stock portfolio. 
This is apparent from the preferences investor show. Some are very conservative and invest only in safe large cap stocks maybe sacrificing potentially higher returns even when they need it to reach their goals. Others are aggressive and invest predominantly in small cap stocks to earn higher returns and suffer pangs of anxiety when the market corrects. It does not have to be an either-or choice and that is achieved by selecting the 1st Gate wisely. 
Stocks exhibit a difference in how much returns they deliver and how volatile (price fluctuations) they are. After much research we arrived at a way of looking at stocks taking this into account and ascribing a role to them in a portfolio and also how we take decisions about them. This led us to look at stocks as Core and Booster Stocks

Core Stocks: 

These stocks are mostly leaders and highly efficient companies with low to moderate impact from an economic slowdown, competition, or governance i.e. consistently performing companies.
These Stocks are predominantly large cap and non-cyclical and hence less volatile –lower corrections and quicker return to fair prices.
They must be bought at reasonable prices (because they tend to get expensive) and held through thick and thin.
Even though their returns will be moderate versus Booster this portion of the portfolio will be less volatile and more consistent.
Examples of Core Stocks: Nestle, Titan, HDFC Bank.
Why you must have Core Stocks? More consistency in returns as seen in every 3-year period; helps you stay invested in the equity market.

Booster Stocks:

Booster Stocks (predominantly mid and small cap and cyclical) consists of high growth, emerging companies in a sector, and shown execution track record but not tested for resilience from an economic slowdown, competition, etc.
They need to be bought only if they are going to provide a boost to overall portfolio returns.
If the prospects are deteriorating, they need to be sold quickly at small losses as chances are they may not recover to their earlier performance, unlike Core Stocks. This will result in more buy and sell from time to time.
These stocks can earn high returns but their performance will be inconsistent. But because of the stability of Core Stocks, you will stick with Booster Stocks too.
Examples of Booster Stocks: Changes from time to time, but...........Read More

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