Why some people buy individual stocks when most feel impossible to do

[Totoro]

The point where we diverge I think is that it can be alot less risky to own one company vs. the whole market.

As a theoretical example: suppose a listed company only has cash worth 100 B$, and is listed for 40$B. It has nothing else (no employees, production, ..).

Buying that company, delisting it and getting the cash out has virtually zero risk.

In the past the rough equivalent of that scenario (e.g. extremely undervalued real estate hidden in the balance sheet) has existed.

How would diversification help you here? It's not stupid to put all your money in one place if that place is safer and offers higher returns than all the alternatives.

Since few opportunities are so clear cut it does make sense to diversify usually though. It is a margin of safety one can build in if required.

The question then is whether one believes you can narrow down the certainty of value enough to not need the diversification route in practice.

Some people think they can, others don't and everything in between. Extreme at the one end means indexing only, extreme at the other end means concentrating in one company.

Another example, a bit more practical: suppose I invest in two companies to diversify. And then these two companies merge. Has my risk profile changed? Should I sell half my holdings and find another company to diversify?

Diversification has its merits (I use it myself!), but it's just another tool, not always the best one for everyone in my book.

 

[Dash man]

I'm a fan of both stock picking and diversifying using index funds. The index funds are in our 401k accounts and we stock pick in our taxable brokerage account. We consider ourselves diversified in our individual stocks too because we own about 25 stocks across several industries, and buy what we believe are the best. Index funds unfortunately also bring along loser stocks with them. Our largest gains have been in the individual stocks over time and they are what have made us very comfortable. None of them are the sexy stocks you hear about on the business news channels, but have done very well over time. Accumulating shares in the strongest companies does allow your portfolio to grow faster than index funds, but it is a riskier game overall because there are unknowns that can hit any company. Fortunately for several of our picks, the unknowns have been positive.

 

[Fermion]

The point where we diverge I think is that it can be alot less risky to own one company vs. the whole market.

As a theoretical example: suppose a listed company only has cash worth 100 B$, and is listed for 40$B. It has nothing else (no employees, production, ..).

Buying that company, delisting it and getting the cash out has virtually zero risk.

One might think this example has no risk but unless you are in total control of said company, there is always some hidden risk. The company may fall under some litigation for past product/service, they may choose to poorly invest the cash (this has happened to me more than once...the worst case being a mining stock that had 2x more cash than market cap and lost it all trying to build/expand their mines)

 

[samclem]

Accumulating shares in the strongest companies does allow your portfolio to grow faster than index funds . . .

Somebody should tell this to the majority of active fund managers, who consistently underperform their appropriate indexes. "Accumulate shares in the strongest companies" . . . they just didn't know this neat trick!

 

[haha]

I do not understand why people participate in these discussions. Every investor knows here he or she stands. Can anyone think that they are going to discover some new fact here, that they have never run across in the previous years of being an investments junkie?

 

[Dash man]

I do not understand why people participate in these discussions. Every investor knows here he or she stands. Can anyone think that they are going to discover some new fact here, that they have never run across in the previous years of being an investments junkie?

They participate because they can. It's nice having loads of free time

 

[RISP]

I do not understand why people participate in these discussions. Every investor knows here he or she stands. Can anyone think that they are going to discover some new fact here, that they have never run across in the previous years of being an investments junkie?

I do not understand why people keep posting what they think others should or should not do, over and over and over again.

 

[RISP]

I only buy individual stocks and individual municipal bonds. [...]

The above has worked well for me for 30 years. I am 55. Have been FI for many years but am still working. I own my own business. I have been able to diversify as I see fit. I realize the above is not for everyone but those are my reasons.

I've been thinking about buying individual stocks to avoid fees, but my portfolio is still too small. I would want to own about 30 different stocks, and the transaction costs to build such a portfolio would not be justified IMO. Not to mention adding to it every month while keeping the allocation I want.

May I ask how many individual stocks you hold at any given time? I like to have a lot of international exposure, both in developed and emerging markets. This makes it quite tough to cover all countries and all industries I want to be invested in. So for me, it's indexing for the time being.

 

[RISP]

The point where we diverge I think is that it can be alot less risky to own one company vs. the whole market.

As a theoretical example: suppose a listed company only has cash worth 100 B$, and is listed for 40$B. It has nothing else (no employees, production, ..).

Buying that company, delisting it and getting the cash out has virtually zero risk.

In the past the rough equivalent of that scenario (e.g. extremely undervalued real estate hidden in the balance sheet) has existed.

Well, I know for a fact that for example Gazprom is trading well below what it should be worth. You can purchase its assets for pennies on the dollar. But, that has been the case for years, and there are good reasons for the discount (exchange rate risk, political risk, listed in an undemocratic country with sub-standard regulation, ...). Unless the market starts agreeing with me on Gazprom's intrinsic value, owning it's stock doesn't do me any good. And in addition to that: Would I want to be heavily overweighted in Gazprom, or have it as my single stock holding? Of course not.

Another example, a bit more practical: suppose I invest in two companies to diversify. And then these two companies merge. Has my risk profile changed? Should I sell half my holdings and find another company to diversify?

Yes and yes, of course. Absolutely. If a strike hits this new, merged company, 100% of your portfolio is affected. If an earthquake damages their server farm, the IT infrastructure of your entire portfolio is down. If management makes a poor decision, all your equity holdings are in danger. Etc. etc.

 

[phil1ben]

I've been thinking about buying individual stocks to avoid fees, but my portfolio is still too small. I would want to own about 30 different stocks, and the transaction costs to build such a portfolio would not be justified IMO. Not to mention adding to it every month while keeping the allocation I want.

May I ask how many individual stocks you hold at any given time? I like to have a lot of international exposure, both in developed and emerging markets. This makes it quite tough to cover all countries and all industries I want to be invested in. So for me, it's indexing for the time being.

I have about 40 different stocks and normally have 150 different municipal bonds. I have discussed this on other threads. I am in the finance industry and I am comfortable doing my own analysis. I spend approximately 45 minutes a day reviewing news and searching for bonds either newly issued or on the secondary market. Bonds I almost always hold to maturity. I probably make about 20 stock trades per year.

 

[Totoro]

Phil1ben: Can you elaborate maybe a bit on why you feel confident doing this?

So not the inherent tradeoffs (I think we all know them), but why you personally think you can?

 

[phil1ben]

Phil1ben: Can you elaborate maybe a bit on why you feel confident doing this?

So not the inherent tradeoffs (I think we all know them), but why you personally think you can?

I feel my education, experience and background is better than the 40 year old portfolio manager picking stocks and bonds in a fund. I deal with many of these people everyday and see no reason to pay them for what I can do myself.

By way of example I can read Apple's earnings released earlier this week and determine for myself whether I believe the stock acted properly and, therefore whether to buy or sell. I prefer to pick individual securities rather than a bundle picked by others. Admittedly, this takes a degree of time and the inclination to do the evaluation. Many do not wish to devote their efforts to either and for them relying upon a fund or ETF makes perfect sense. For me it does not.

 

[target2019]

How many stocks?
We have 26 positions in a brokerage we look after (not ours). The current target AA is:

2.5% - Financial : 1 stock
2.5% - Consumer Discretionary : 1 stock
2.5% - Technology : 1 stocks
2.5% - Industrials : 2 stocks
2.5% - Materials : 1 stock
5.0% - Energy : 2 stocks
2.5% - Consumer Staples : 0 stocks
5.0% - Health Care : 1 stock
25.0% - Telecom Services : 4 stocks
5.0% - Utilities : 2 stocks
10.0% - Real Estate : 3 REITs, 2 ETFs
15.0% - TE Long Term : 1 fund
10.0% - TE Short Term : 1 fund
5.0% - High Yield : 1 fund
5.0% - International : 3 ETFs

The telecom and tax-free were the starting positions. They were doing very well, and in-laws wanted to keep them as is. Initially we focused on dividends. The situation changed in a few years, and now we feel secure in looking more at income and growth.

We're using ETFs to cover international. In each US stock sector we look for 2 companies to invest with.

There are opportunities to simplify in the future. Trying to stay under 30 positions as the maximum.

Other income sources currently cover all expenses. Other investments are managed conservatively.

I participate in threads like this one because I always learn something new. I'm not trying to convince anyone that one approach is any better than another.

 

[Running_Man]

I do not understand why people participate in these discussions. Every investor knows here he or she stands. Can anyone think that they are going to discover some new fact here, that they have never run across in the previous years of being an investments junkie?

I participate in these discussions because I enjoy the sharing and challenging of ideas, and therefore through responding actually can reflect if my position at a given time truly is making sense.

I will give you that for some who have seen the same arguments time after time, they appear repetitive, but that is a small price to pay for challenging an opinion. Otherwise there is just too much plain pack mentality. I find the board far more open to discussions than other years when 2 or 3 massive posters controlled every thread.

 

[Running_Man]

I do not understand why people keep posting what they think others should or should not do, over and over and over again.

Ha Ha is a venerable poster with a great deal of wisdom behind his words, they should be considered very carefully, even if you disagree with them.

 

[Running_Man]

Somebody should tell this to the majority of active fund managers, who consistently underperform their appropriate indexes. "Accumulate shares in the strongest companies" . . . they just didn't know this neat trick!

Actually I think this is one weakness of managed fund managers, for instance the #1 stock underrepresented the last 2 years in managed funds has been Apple,
Is Apple, world’s largest stock, ‘underowned’?
The problem is I think when they have a winner, pressure being put on to beat indexes makes them sell to lock in gains to try and beat indexes, well, that's my theory anyway don't actually personally know any fund managers. Not having to answer to complaining customers is a big advantage for an individual stockholder.

.

 

[Fermion]

Active fund managers have the problem of the uncertainty principle that smaller individual investors don't have. Their transactions can move the market just by them looking at it, where individual investors can buy/sell without much of any disturbance in the position or velocity of a stock.

I think Buffett said this when he admitted he could make a much larger % gain with a million dollars to invest than a billion.

 

[MRG]

Active fund managers have the problem of the uncertainty principle that smaller individual investors don't have. Their transactions can move the market just by them looking at it, where individual investors can buy/sell without much of any disturbance in the position or velocity of a stock.

I think Buffett said this when he admitted he could make a much larger % gain with a million dollars to invest than a billion.

+1
My limited experience is I do much better with individual equities. That said, I'm not up to the challange or risk of managing my entire portfolio.

 

[kcowan]

I have several funds that cover Europe, Brazil, China and India. For US/Canada, I hold 16 stocks in a highly concentrated portfolio. I watch earnings and trends in earnings. Would I recommend this approach to anyone else? No it is a matter of history that I built the portfolio and the add/drop rules over a period of ten+ years.

I have had a few 10-baggers over the years and no dead losses. But now I am on auto-pilot with mostly divvies. The 10x ones gave us the portfolio size to be able to relax....

(In terms of this discussion, there is no answer other then "It depends"! I would suggest that anyone embarking on it would need an above average analytic capacity and enough runway to make it worthwhile.)

 

[haha]

I do not understand why people keep posting what they think others should or should not do, over and over and over again.

If you had read carefully, you would have noticed that I didn't say, and would not say, that someone should or should not participate in this type discussion. I just asked why they do, since index investors in particular are usually 100% sure of their approach. There are attitudes that might have more chance of being moved than the opinions of this sort of investor. Running man, a very successful single stock investor, gave his reasons. Don't forget, the title of this thread was "why some people buy individual stocks". So it seems to be about why some people do things that that clearly do, such as buy individual stocks, and participate in these more or less unending poster faceoffs. Which I am now doing!


Ha

 

[haha]

Since I am here, I will give my reasons for buying individual stocks.. My reasons are better control over taxes, predictable income, not owning anything that I think is priced beyond its green eyeshade current worth. I never want to buy anything where it appears that good news will not as positive as bad news may be negative. I do not think that I know more about many stocks than other active investors, but I also have found that this is not necessary. Occasionally I may buy something here in the northwest that is hugely underpriced. Over the years this has often been timber companies. For years I attended annual meetings of local timber companies. Listening to questions from wall streeters, I judged that they know finance, but not timber growing. Just like Iowa is the best home for corn, western Washington and Oregon are home of the finest Douglas fir plantations in the world. If I find something like this well priced, I am not shy about buying a lot of it. That game is ending as almost all the timber is now owned by REITs and private funds. At times I have through stocks owned the same timberland through several ownerships. This type of thing would never compare as to returns with a very good speculative trader, but it suits my knowledge base and my temperament and I judge that it is very safe. On the other hand, I miss a lot. One of my sons was an early employee at Microsoft, and I avoided investing in it because I knew I did not understand. Ditto Amazon, and that one was available at less than $4 after the millennial crash. I thought that they were likely getting out of their sweet spot when they started selling goods other than book and music. Wrong, wrong, wrong! Jeff Bezos is an authentic genius, it would not surprise me if he wound up on top of the heap in the Cloud market. But it is not a bet I am interested in.

Due to a successful outcome I sometimes find myself owning more of something than I might prefer, and this may go on for a while because of tax strategies. Although this makes me somewhat nervous, it also makes little sense to me to take equity risks, then surrender a lot of a positive outcome to the government.

At times I will make commodity based bets that are lopsided. Not a great idea perhaps, but in over 40 years these have never failed to work out on balance.

Ha

 

[clifp]

I've been thinking about buying individual stocks to avoid fees, but my portfolio is still too small. I would want to own about 30 different stocks, and the transaction costs to build such a portfolio would not be justified IMO. Not to mention adding to it every month while keeping the allocation I want.

May I ask how many individual stocks you hold at any given time? I like to have a lot of international exposure, both in developed and emerging markets. This makes it quite tough to cover all countries and all industries I want to be invested in. So for me, it's indexing for the time being.

Actually the fees for buying individual security can be lower than even index funds, even for modest size portfolio. I see you are in Germany and so price maybe different there. But in the US it even the full service discount brokers like Schwab charge $9 to trade, it is easy to find $5 trades and many places offer you 50 free trades or so for opening a new account. So at $5/trade buying 30 stocks at $2K each would cost $150. Let say you buy and sell 3 stocks a year that's $30 Over five years you have spent $150+4*$30= $270 dollars in commission. . For international funds the ER is higher VEXUS is .14% or $84/year on a $60K portfolio over 5 year you'd save $150. Not a huge amount of money but when you have $1 million plus portfolio it become a signficant.

To me by far the best way for somebody who is in the accumulation phase to get into individual stocks is to start small. Divert 20-30% of your savings from index funds into individual stocks and buy 2 or 3 a year max. If you want to buy more than that sell an existing holding. I think you want to invest between $1,000-$3,000 per stock. Enough money that if it triples you'll feel happy, and not so much if it goes down 75% you'll be devastated.
Don't worry at all about diversification since ~80% of your assets are still in index funds. Frankly I find it hard to come up with more than 3 conviction stock buys a year (especially in today's expensive market)

Devote as much time to researching each individual stock as you would do a similar size purchase e.g a bed or a computer. After 5 years you'll have a decent size portfolio of 10-15 stocks that hopefully is worth nearly $50K. At which point it is is time for a self assessment. Since you are 30 you'll probably have your desired 30 stock portfolio in a dozen years near when you are looking to retire.

The first question is do I enjoy doing the research if the answer is no I find it a burden, than sell invest in index funds and don't look back.
The second question is how did I do relative to my index fund investment. This is a harder question to answer because the individual stock investments are almost certainly riskier than your mutual fund investments.
But it should be relative easy for you to calculate which made me more money investing more in the mutual fund or individual stocks.

Investing is one of the rare things that continues to improve as you age through your 50s.

I find this recent article M* about the advantage of owning individual stocks which touched on many of the points made in this thread.

 

[Running_Man]

First, I do zero research on stocks & use indexes.

But cherry-picking one stock vs. an index to look backwards with to try to make a point is a mere anecdote & thus invalid for demonstrating anything other than the stock did well. Certainly doesn't demonstrate stock-picking is better than indexing.

Now name 10 stocks today & compare vs. an index or indexes that cover the same type stocks & see 1-5-10 year results & win, then you have something.

This was in response to my post which was somewhat long about the process I go through to select individual stocks in order to create a portfolio of dividend income that will grow much faster than the indexes and therefore create better value.

The stock I used as an example was Amgen which I had just purchased at $129, but more importantly paid a dividend of 2% at the time and I set a forecast of future dividend increases which should vastly outpace VTI. Some posters took this as if I was trying to compare buying AMGEN to VTI. I was not posting to tout AMGEN or to compare to an index, I posted to show the process involved one could use to select individual stocks in a profitable manner based on their dividends. That the process I used in selecting AMGN has resulted in a stock that has vastly outperformed VTI since then is nice, but not the purpose of the post. That the dividends received from AMGN and will continue to receive will greatly outpace VTI was the purpose of the process. The price of AMGN is dependent on factors upon which I cannot control, but can use to benefit from at time of purchase and time of sale.

The most important thing to me is to select a portfolio of stocks that can meet the goal of growing dividends faster than inflation (usually at least twice the inflation rate) to provide an ever increasing stream of income. One of my key criteria is to avoid companies that appear to not be able to grow dividends and actually may have to reduce dividends. Sometimes this results in avoiding an entire very popular sector, such as Banks in 2007/2008 or oil stocks in 2015. I do not short stocks, I just avoid them. The group I felt back in the 4th Qtr of 2014 to avoid for 2015 because of the poor dividend prospects was the oil company and Energy sector MLP's, which many investors were drawn to like moths to a porch light because the price of oil had fallen, and the stocks had dropped a small percentage. Buying stocks merely because they have fallen in price I think makes an investor think he has contrary thinking, but this is actually a fairly common activity. Sometimes from the ashes massive winners can arise, such as APPLE, Netflix etc, but I am not looking for those types of stocks.


I look for stocks that are priced favorably based on their dividend prospects. This results in times in my buying stocks that yield 2 percent or perhaps even 8 percent. Of course the price of the stock factors into the decision but it is the price/dividend relationship that determines whether the stock is a good investment in my mind not the price of the stock. In the case of AMGEN, I did purchase because the stock fell to a price based on a dividend yield of 2 percent that I thought was quite a bit better than average based on future dividend purposes, they are outperforming my forecast for them and increased the dividend 30 percent in 2015 and probably will increase it greater than my 15 percent forecast for 2016, but even if they only match my expectation the stock I purchased at a 2 percent dividend in 2016 will be paying 50% more in cash to me than when I purchased it and frankly the outlook is for much of the same for years to come at this point. I love their management team which

At the time of posting about AMGN I was not looking backwards but forwards and frankly since posting my thoughts on individual stocks since 2007 and being asked by index advocates on multiple occasions to show a 10 year record before my comments could possibly have any merits is a personal opinion of other posters who I am free to ignore. I am not concerned if time will show my opinion and detailed recommendations will show no merit because I do not have to answer to anyone but myself. Avoiding large losers is more important than having large winners, as long as the dividends forecast come to fruition as budgeted.

I post ideas on topics which of which I think have I have something of merit to add. Investing in the manner I do is actually fairly strait forward, does not require extraordinary effort or intellect, yet results in superior results in the long run for me. Disagreeing with me on this is expected from most index advocates.

 

[kgtest]

Avoiding large losers is more important than having large winners, as long as the dividends forecast come to fruition as budgeted.

I post ideas on topics which of which I think have I have something of merit to add. Investing in the manner I do is actually fairly strait forward, does not require extraordinary effort or intellect, yet results in superior results in the long run for me. Disagreeing with me on this is expected from most index advocates.

For me, this direction and way of thinking is automatic. When the market moves, it moves wether positive, or negative...but when it moves negative there is a lot of reactive actions that IMO leads me to believe it is more important to avoid picking the larger losers. I am not looking for the 10x walk-off homer, just a nice RBI.

 

[Totoro]

The most important thing to me is to select a portfolio of stocks that can meet the goal of growing dividends faster than inflation (usually at least twice the inflation rate) to provide an ever increasing stream of income.

What do you think about big tobacco stocks / companies?