If I told you I would hand you some money to buy a few shares of a stock, but only if you could tell me which company was at the top of your buy list, could you do it? Most investors probably could do no more than toss out a random name, because few keep an up-to-date short list of their best investing ideas.
Yet such a list is crucial -- even beyond the obvious reason of knowing which stocks to buy when opportunities arise. The very act of diligently keeping such a list will sharpen your investing skills. It forces you to develop a thesis for every company and constantly reassess that business to make sure your thesis still holds. You'll also be in better tune with valuation, especially relative to other companies in the industry.
For example ...
My own portfolio includes full positions in some stable, blue-chip stalwarts such as Procter & Gamble (NYSE: PG). I also have lighter positions in some small caps, Buffalo Wild Wings (Nasdaq: BWLD) among them.
So when it came time to add new money a few years ago, I had good balance in my portfolio and was free to consider almost any stock. For many reasons, including solid management, reliable cash flows, and compelling valuation, Johnson & Johnson (NYSE: JNJ) had been on my short list. After a 10% drop in less than a month, it had moved up to No. 1. I pulled the trigger in early February 2006 and got in at $56.95.
Of course, only time will tell whether that was a good buy -- but so far, so good, as I've gotten positive returns during a time the S&P 500 lost over 30%. Because I keep an up-to-date list of my best stock ideas, I was able to buy with confidence when the opportunity presented itself.
Look inward, grasshopper
When making your list, don't forget stocks you already own. All of us will have a limited number of great ideas in our investing lifetime. Often, your best stocks are already sitting in your portfolio, just waiting for new money.
Most of history's greatest investors followed this route. You may already be familiar with Charlie Munger's disdain for overdiversification; he'd rather have his money in a small handful of stocks and would allocate not a single penny to any second-tier idea. David and Tom Gardner are thinking along the same lines for their Motley Fool Stock Advisor members. Each month, they publish their top five stocks to buy now for those ready to allocate new money.
But don't think that you need to limit yourself to just four or five stocks. In fact, the less experienced you are as an investor, the more diversity you need in your portfolio, to keep one or two bad mistakes from torpedoing your net worth. Masters such as Munger and Buffett are tops in their field; they're not perfect, but it's highly unlikely that any one investment of theirs will completely tank and significantly harm Berkshire Hathaway shareholders. The rest of us, however, need a bit more diversification.
But no matter your investing experience, you'll want to focus on your best ideas as you add new money. And as the years roll by, if you were right about most of your ideas, the extra concentration in them will supercharge your returns.
The short story
Do you need help compiling your own short list? The most important consideration, especially for the average individual investor, is balance: between large and small caps, between less risk and more risk, and among different industries. As any chart will show, if you owned ExxonMobil (NYSE: XOM) five years ago, buying another oil giant like ConocoPhillips (NYSE: COP) would have added no diversification benefit and overweighted you in one industry. Same with Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP) -- it's not that one stock won't outperform the other; it's just that owning full positions in both exposes you to higher risks and less diversification.
And don't be afraid to seek out qualified help. As I mentioned, David and Tom now publish their own short lists in Stock Advisor; each list contains their five best stock picks for new money now. They happen to be pretty good at what they do, with their average recommendation beating the S&P 500 by 29 percentage points.
It won't cost you a dime to see their lists and all of their recommendations. If you're interested, click here for more information on a 30-day free trial.
This article was originally published June 10, 2006. It has been updated.
Rex Moore
parks in a driveway and drives on a parkway. He owns shares of Procter & Gamble, Buffalo Wild Wings, Berkshire Hathaway, and Johnson & Johnson. Buffalo Wild Wings is a Motley Fool Hidden Gems selection. PepsiCo and Johnson & Johnson are Motley Fool Income Investor recommendations. Coca-Cola and Berkshire Hathaway are Motley Fool Inside Value picks. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Buffalo Wild Wings, Berkshire Hathaway, and Procter & Gamble. This information is brought to you by the Fool's disclosure policy.
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