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Differentiating Asset Allocation and Diversification

TIP Guy 11 July 2009 asset allocation, process, risk management No Comments

portfolio-makeupAny investor investing for long term (i.e 10+ years) must use the principles of asset allocation and diversification in their portfolio management process. These are two aspects that help investors to manage risk of investments. This has been said many times, presented many times, and we individual investors still continue to make mistakes. On a personal front I have been guilty of it in recent past. Both asset allocation and diversification are two different aspects and hence they have different objectives. The primary reason individual investors get exposed to downside risk is because many are unable to differentiate between these two aspects.

Asset allocation is a strategy of allocating capital to different types of assets which are either non-correlated or at least have low correlation. The notion here is that, over time, the volatility in returns will smooth out if they have low correlations. The different types of assets that I am discussing here include, cash, government bonds, corporation bonds, common stocks, preferred stocks, real estate, private equity, natural resources, commodities, partnerships, etc.

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Risk Analysis of TIP Portfolio – 1H09

TIP Guy 23 June 2009 process, risk management, strategy 4 Comments

Any long term investor will know that they need to manage risk in their portfolio. The way individuals should manage their risk is asset allocation and diversification. Today, I am discussing how I manage risk in our income portfolio. The objective of this risk analysis is to make sure that TIP portfolio is not exposed to any particular event, or company, or any other aspect that will affect portfolio performance.


My portfolio management process has a risk management process in which I try to:

  1. Maintain pre-determined asset class allocation;
  2. Maintain pre-determined diversification, any sector should not exceed 10%;
  3. Any single stock should not exceed 7% of the portfolio;
  4. Dividends from a single stock should not exceed 5% of total dividend cash flow.

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Income Portfolio – Quarterly Update 1H09

TIP Guy 20 June 2009 process 3 Comments

updateOne common question that I continue to receive is about the efficacy of long term investing. The notable factor is almost all of them use two specific examples to explain that long term investing is not a viable solution. These examples are (1) Stock market tanking in 2008; and (2) Satyam going kaput.

To begin with, it tells me that many do not understand what is investing. Folks who ask these questions do not understand long term investing. I keep wondering, how to best explain what is long term investing.

In general, first half of 2009 can be characterized as roller coaster ride. While we saw multi year lows, at the same time, we also saw historical one day rally. In my post bull running for red flag, I showed that majority of SENSEX companies are showing reduced earnings. And surprisingly, it is being rewarding by increase value. I continue to believe, there is no way any individual can predict the markets. So who bother wasting time on it?

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Estimation of Stock’s Fair Value Price Range

TIP Guy 13 May 2009 process, tools 26 Comments

monthly-dividend-portfolio-reviewIn my stock analysis process, I attempt to estimate the fair value of a given stock. I estimate the fair value range (instead of a one fair value). This estimation should be interpreted as the price I am willing to pay based on my risk profile and my investing objective. My fair value estimation does not necessarily attempt to determine the fair value based on value investing principles.

My process of determining the fair value captures the essence of “what is being priced by the market” and “historically what has been priced by the market”.

(I) NPV price based on 15 year DCF: I have discussed DCF based net present value pricing.

(II)  Average high yield price calculated based on past 10 years

I am attempting to estimate what would be current stock’s price based on its historical dividend payment standards. I measure this using yield. It is calculated as follows. Continue reading rest of this article…

Fair Value Estimate – Discounted Cash Flow Method

TIP Guy 2 May 2009 process, tools 9 Comments

monthly-dividend-portfolio-review1In my stock analysis process, among others, one of the methods I use to estimate fair value of a given stock is using 15 year discounted cash flow (DCF). At a fundamental level, what DCF does is, it uses future cash flow estimates and then discounts it to determine the present value. Let us discuss both of these parameters.

Future cash flow estimate: There are myriad of different ways to estimate future cash flow of any corporation. These are based of EPS, free cash flow, operating cash flow, net profit, pre-tax profit, etc. I am not qualified to judge or make any comment on the correctness or appropriateness of using any of above parameters. I believe based on a specific objective any or all could be correct. I look at DCF methodology from my own investing situation and objectives.

I am a long term dividend investor and hence, I use estimates of cash flow from dividends. In addition, I also include an estimation of cash I would receive from selling the stock after 15 years.

Discount Rate: This is the rate at which future cash flow is discounted to determine present value. The general practice is to use cost-of-capital that is available in any given market. I have observed that, typically, discount rate is in the range of 12% to 18% depending upon individual scenarios.

In my calculation, I tend to use 12% in most cases.  Continue reading rest of this article…

Estimation of Beta-Based Expected Returns

TIP Guy 16 April 2009 process, tools 10 Comments

monthly-dividend-portfolio-reviewI use Beta-based expected return to calculate and understand potential capital appreciate (or cash flow) from a given stock.

In today’s post, I am discussing the concept of stock’s beta value and how it helps us understand stocks expected returns.

What is Stock’s Beta Value?

In its simplistic form, beta is a measure of any individual stock’s risk (or movement) relative to the overall stock market risk (or movement). I measure Beta of any given stock relative to the S&P CNX NIFTY. Here, I am trying to understand how a stock price behaves relative to the market and how to factor in the capital appreciation into my expected returns. We can calculate Beta either using daily return (i.e. daily pricing) or on monthly returns (monthly pricing). The results should be the same because it is the on relative basis.  Continue reading rest of this article…

Dividend Stock Analysis Process and Parameters

TIP Guy 3 April 2009 process 9 Comments

The objective of my income portfolio is to make investments that result in continuously increasing cash flow. My expectation is that the capital allocated to this portfolio will not be required for a long period of time (i.e. 15 years or more). This allows me to make investments in individual stocks and take higher risk relative to the market. The process and parameters that I use in my evaluation are as follows:

Trend Analysis

The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends for past 10 years.

  • Revenue
  • Earnings per share
  • Net cash flow from operations
  • Profit/Loss from operations
  • Reported net profit
  • Gross margins
  • Operating margins

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