Improve your odds of investment success with these three stocks
Professional investor Tom Wildgoose of the Nomura Global High Conviction Fund highlights three of his favourite stocks.
How much should you allocate to a great investment idea? Over 60% of the Large Cap Active Global Equity portfolios in a popular fund database have more than 50 stock holdings. That implies an average investment of around 2% of the portfolio and, say, 3% for the best ideas.
Almost 40% of the database is made up of funds holding more than 80 stocks, which tend to invest even less than 2% in individual investments. This seems quite low, especially for a best idea, which is where John Kelly comes in.
Kelly was a scientist working on noise reduction in long-distance telephone signals at the famous Bell Labs in the 1950s. But it turns out that his algorithm was useful for sizing gambling bets appropriately for a given set of probability-weighted outcomes. The “Kelly criterion” calculates the portion of funds you should place on a bet, with probability-weighted win/loss outcomes, to maximise your long-term return.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Playing with probabilities
We know that investments can be winners (or not) and we can estimate the degree and probability of the win. So the Kelly criterion is useful for investment decision-making as well as Las Vegas.
Let’s say we have a great investment idea with a 75% chance of 30% upside, but a possible 10% downside. Kelly suggests you invest two-thirds of your available funds with an expected return of 20%.
Interestingly, by working the Kelly criterion backwards, we can infer what a portfolio manager thinks of his or her best ideas given the amount invested. For example, a 3% position (roughly 2.5 times the average weight in an 80-stock portfolio) implies that the manager sees the idea as having equal upside and downside but with an upside probability of 51.5%. This does not sound very convincing, and of course the manager is unlikely to agree with that range of outcomes and probabilities. So why not concentrate the portfolio on the few best ideas and forget about the rest? That is what we do. Here are three stocks that we hold with real conviction:
Growth potential in the cloud
Alphabet (Nasdaq: GOOGL) is a well-known internet service provider; the search engine and YouTube form the foundation of the company. Alphabet’s ability to continue to grow its share of advertising revenue is underappreciated, while you might not realise that it has a large cloud- computing business, an area that offers long-term growth.
DaVita (NYSE: DVA), provides dialysis treatments for patients suffering from end-stage renal disease (ESRD). Costs and a rise in client mortality owing to Covid-19 have been a problem, but the market does not appreciate the likely margin improvement as costs normalise. The transfer of patients from Medicare to Medicare Advantage (under the US healthcare system) also offers the potential for margin improvement.
Consider also NVR (NYSE: NVR), a housebuilder in the US with a geographically focused operation (some rivals spread themselves too thin) and a policy of not buying land. This allows it to benefit from economies of scale in construction and minimise the capital employed in the business, improving returns on capital, an important gauge of profitability. It is an unusually shareholder-friendly company.
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
-
Skipton launches a retirement bond with monthly income – is it any good?
The building society has launched a new three-year fixed-rate bond for those aged 66 and over. Can it boost your retirement income?
By Katie Williams Published
-
Pensions: 140,000 pensioners to be hit by surprise tax demand
Tens of thousands of pensioners will be written to over the summer because their pensions have gone above the frozen income tax thresholds
By Chris Newlands Published
-
Netflix steams ahead of its competitors
Netflix has beaten its rivals, so how can it keep growing?
By Dr Matthew Partridge Published
-
UK mid-caps: an improving outlook
UK mid-caps have perked up and the rally may run further, but long-term investors should remain selective
By Cris Sholto Heaton Published
-
The tobacco industry is going smoke-free - how to profit from it
Tobacco companies have realised their traditional products are on the wane. But new opportunities have opened up – and should prove lucrative
By Rupert Hargreaves Published
-
Is it time to invest in creative industries?
Any industrial strategy should not overlook the creative industries, one of our top national assets
By David C. Stevenson Published
-
Is Mercia Asset Management set for success?
Mercia Asset Management helps the government fund smaller companies in Britain’s regions. Should you invest?
By Rupert Hargreaves Published
-
British stocks set for a boost
British stocks are due for a bounce as the UK looks more stable compared to many economies
By Alex Rankine Published
-
Ocado shares jump by a fifth
Ocado takes a turn for the better after attractive profit forecasts were announced
By Dr Matthew Partridge Published
-
The AI boom is on borrowed time
The hype around the AI boom could be on its way out – but why?
By Alex Rankine Published