During the discussion of asset allocation strategy, we have discussed how you can diversify your investment portfolio among the different asset class like gold, equity, bonds, and debt instruments with the asset allocation strategy. Asset allocation strategy enables an individual investor to diversify or mitigate the risk by making an investment in different asset classes. It also delivers decent returns according to an individual’s risk appetite and time horizon. In this column, we will discuss how to diversify stock portfolio which may help you to mitigate the risk and deliver decent returns.
How to diversify stock portfolio and its benefits
The basic investment strategy is that while you invest in the stock market you need to invest in those stocks or sectors whose business model is clear to you i.e., how the company earns money, whether it will exist after 20-30 years, the risk factors associated with the company etc. The next thing is to consider the market capitalization of different sectors such as Banking, Information Technology, Finance, Pharmaceuticals and health, Auto, Petroleum, Power, and Engineering etc. At the time of choosing sectors, all you need to do is to focus the mother sectors like the above-said sectors which will be there even after 100 years. Then you must
- Read also: 5 Tips For Diversifying Your Portfolio – Investopedia
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Here is the snapshot of different sectors,
| Sectors | Market cap in Rs. Crore |
| Banking | 1922004 |
| Information Technology | 1594493 |
| Finance | 1481891 |
| Auto | 632937 |
| Auto Ancillary | 234800 |
| Engineering | 343081 |
| Paints & Pigments | 206434 |
| Consumer Durables | 141617 |
| Food Processing | 225832 |
After making an analysis of sectors, you need to
Debt: Net Worth ratio
If the company has marginal or low debt or it is a debt-free company, the company is worth investing. If the company has marginal or low debt or is a debt-free company, the company is worth investing. Let us illustrate what is the difference between a high debt company and a debt-free company. When a company has huge debt from the market or bank or commercial institutions, then the company will concentrate on the debt and its effort will be to pay off the debt. It cannot be sincere about the service, quality of the product or any other important aspects needed for the business. If the company is debt free, the company will concentrate on product quality, service and customer satisfaction only. That is why a debt-free company is better than a high debt company.
Compounded sales Growth
Select a company that has been generating sales Growth annually during the last 5 financial years of at least 10%. When a company’s sales increases, then naturally the company will make more profit. So this will affect its share price.
Profit after Tax (PAT) growth
Choose a company whose profit growth increases at least 15% on a year-on-year basis. We can take the example of Titan Company. Titan Company’s profit growth in 2018 has
Return on Equity
If a company fails to give you a yearly return of at least 20%, you may stop investing in that company and move to another one.
Here is a list of stocks which satisfy the above-said points.
| Banking Sector | ||
| Points | HDFC Bank | Yes Bank |
| Compounded sales Growth | 18.01% | 19.57% |
| Compounded Profit growth | 21.05% | 26.56% |
| Return on Equity | 18.60% | 19.48% |
| Information Technology | ||
| Points | Cyient Ltd. | Infosys Ltd. |
| Debt: Net Worth ratio | 0.03 | 0.00 |
| Compounded sales Growth | 19.23% | 15.50% |
| Compounded Profit growth | 17.13% | 12.87% |
| Return on Equity | 18.25% | 25.66% |
| Finance | ||
| Points | Bajaj Finance | Cholamandalam Investment & Finance Company Ltd |
| Debt: Net Worth ratio | 2.77 | 3.98 |
| Compounded sales Growth | 39.22% | 19.80% |
| Compounded Profit growth | 62.54% | 32.33% |
| Return on Equity | 20.12% | 20.65% |
| Auto | ||
| Points | TVS Motors | Eicher Motors |
| Debt: Net Worth ratio | 0.88 | 0.00 |
| Compounded sales Growth | 16.74% | 14.78% |
| Compounded Profit growth | 22.98% | 42.97% |
| Return on Equity | 25.00% | 28.45% |
| Auto Ancillery | ||
| Points | Minda Industries | Motherson Sumi |
| Debt: Net Worth ratio | 0.17 | 0.77 |
| Compounded sales Growth | 26.05% | 26.01% |
| Compounded Profit growth | 74.05% | 21.04% |
| Return on Equity | 26.01% | 23.71% |
| Engineering | ||
| Points | Graphite India | L & T Technology |
| Debt: Net Worth ratio | 0.00 | 0.00 |
| Compounded sales Growth | 24.06% | 12.69% |
| Compounded Profit growth | 51.85% | 17.65% |
| Return on Equity | 20.13% | 33.38% |
Paints & Pigments |
||
| Points | Kansai Nerolac | Berger Paints |
| Debt: Net Worth ratio | 0.00 | 0.11 |
| Compounded sales Growth | 10.45% | 9.87% |
| Compounded Profit growth | 18.99% | 15.58% |
| Return on Equity | 18.59% | 23.79% |
| Consumer Durables | ||
| Blue Star | Titan Company | |
| Debt: Net Worth ratio | 0.03 | 0.00 |
| Compounded sales Growth | 14.21% | 18.12% |
| Compounded Profit growth | 15.27% | 22.11% |
| Return on Equity | 20.35% | 22.11% |
| FMCG | ||
| Godrej Agrovet | DFM Foods | |
| Debt: Net Worth ratio | 0.01 | 0.79 |
| Compounded sales Growth | 16.12% | 13.56% |
| Compounded Profit growth | 18.09% | 29.67% |
| Return on Equity | 24.28% | 29.21% |
| Insurance | ||
| ICICI Lombard | SBI Life | |
| Debt: Net Worth ratio | 0.10 | 0.00 |
| Compounded sales Growth | 11.49% | 18.03% |
| Compounded Profit growth | 23.48% | 12.79% |
| Return on Equity | 19.74% | 20.12% |
Final Thoughts
So, in this way you can diversify your stock portfolio. Then this diversified stock portfolio will enable you to get better returns in the long term. You may select 25-30 stocks after making proper analysis across various sectors. It is quite easy to track these stocks. The gist is while diversifying your stock portfolio just consider the following points,
- Do not invest in stocks which you have no knowledge about or you do not know the business model.
- Stick to stocks for a long-term horizon instead of worrying about short-term volatility or correction in the market.
- Keep a close eye on quarterly and annual results of stocks you have invested.
- Do not make a stock portfolio consisting of 60 or 70 stocks in accordance with the recommendations of stock analysts or business news channels. In that case, you cannot make surveillance of all those stocks and their performance.
Read also: How to Pick Best Stocks for Consistent Returns
Read also: How to Pick Best Stocks by Growth Investing Method
If you have any question regarding how to diversify your investment portfolio feel free to comment so that we have a discussion. If you found this post helpful don’t forget to share this post.