New Paradigm Investing
Portfolio Management and Kelly Formula

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By whatismyoption
August 29, 2007

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In the last thread I didn't think 11x or anyone was arguing with me and even if they were that's great, discussing all this stuff with smart people is one of the best things about the Fool. So thank you everyone for your thoughts. I have read a lot of posts stating there is no point arguing as you'll never change someone's mind; personally I can't imagine living with such a closed outlook and I primarily discuss things with a totally open mind. I am agnostic on almost everything is life, and your thoughts will be assimilated (resistance is futile).

I've started a new thread as I'd like to read people's thoughts on portfolio management so back to the discussion. The Kelly Formula. I find it useful, so let me explain why. I originally saw little use for the Kelly Formula despite reading many Foolish articles extolling its virtues. As you surmised it was Dhandho that altered my opinion and the main reason was Pabrai's explanation of how it could be used with multiple outcomes rather than the designed two outcomes. To me investing is a comparative task. I have finite money and infinite opportunities so I need methods of deciding which companies I should invest in. As you say investing is not about precision; with a few exceptions investing is based on the numbers you put in, this is true for DCF as it is for the Kelly Formula. For each of these it is not the result of one output that interests me it is the comparison of outputs of all my opportunities that is of interest.

The absolute number from one Kelly output is useless as you say there is no way I would invest 62% of my portfolio in any company. What the outputs do is provide a very quick view and ranking of all my opportunities. I use various inputs based on different numbers I put in. These numbers could be based on technical analysis, fundamental analysis, trading ranges or wild arse guesses, I primarily use a version of DCF, BMW method and trading ranges based on what I consider appropriate metrics. This allows me then to see which companies I should be taking a closer look at.

I use the same method for my portfolio along with Hewitt Heiserman's PIV-ER to give me a perspective on whether I should be looking to add or reduce any holding. I imagine over the years I'll add more inputs to fine tune this, but at the end of the day I want to compare and rank and I find probabilities an essential part of this.

My portfolio spreadsheet currently tells me to look at whether I should add to:
AMGN, CCRT, FMD, OPLK, NFLX, SMSI, PFE in that order.
NUAN, ALVR and ERES have all risen to where I need to look at whether they are worth continuing to hold. And finally BWLD recently pooped up on my top five when it was under $31, as it has a simple story I didn't even need to look further to know to buy.

If anyone has other methods on how they decide which are their best opportunities please le me know, I'm very interested. For anyone that doesn't read the BMW board TwinDeltaTandem did a great post on how he is using Manifest Investing as his comparative tool