Want some steamy shares but don't want sleepless nights? Here are two more ways to be racy without being reckless.
In Part I of this piece, I looked at the vexed question of portfolio weighting. What percentage of your portfolio should a particular share comprise? After all, if you hold several speculative shares and put as much money into them as into safe harbours you may, like the Captain of the Titanic, wish you had not assumed you were iceberg proof.
Here are two more ways to protect your wealth involving upside and volatility.
Upside weighting
How much could a share rise if things go well? Steady growers like Tesco
(LSE: TSCO)
will probably keep chugging out a 10-15% profits rise each year, and a share rise of the same order if the price-earnings ratio (P/E) stays the same. At the other extreme lie companies whose survival is in doubt, jam tomorrow technology shares, and "two guys with a mining license and a pickaxe" outfits.
Take a look at past gains in some well known companies:
Company | Opportunity | Type of share | Price gain | Period |
|---|
Tesco | Market leader, high quality management, consistent 10-15% growth. | Safe FTSE100 | 50% | 2003-2006 |
ARM
(LSE: ARM)
| Still market leader, return to growth | High quality tech recovery | 104% | 2002-2004 |
Marks & Spencer
(LSE: MKS)
| Still market leader, new management, better ranges, costs cut | Recovery FTSE100 | 200% | 2001-2006 |
Cairn Energy
(LSE: CNE)
| Huge oil find | Oil explorer & producer | 400% | 2003-2005 |
Stagecoach
(LSE: SGC)
| Jettison failed US subsidiary, UK public transport growth | Recovery - transport | 700% | 2002-2004 |
Who would have thought that a bus and train operator would have outpaced an oil company that has found a giant field in India? This shows how hard it is to predict how well a company might do, never mind whether it will succeed at all.
For each share you hold take a stab at the possible gain. Aim to equalise possible gain (in Pounds) in each holding. An upside weighted Goldilocks portfolio might look like this:
| Company | Possible upside | Amount invested |
|---|
A | 50% | £200 |
B | 100% | £100 |
C | 400% | £25 |
D | 900% | £11 |
Volatility weighting
Firms like Tesco are the supertankers of the City -- progress is steady, and not much affected by the choppy waters of FTSE changes. Resource companies have become the speedboats -- able to race ahead but will have passengers heaving over the side in bad conditions. The measure of how many per-cent a share changes for every 1% change in the market is called volatility or beta. We can't know the future, so we assume volatility will continue at the same level as the recent past. Here are betas of leading companies measured over the last 90 days, and what the Goldilocks holdings would be:
Company | Beta | Goldilocks holding |
|---|
Tesco | 0.5 | £200 |
Marks & Spencer | 0.7 | £143 |
ARM | 1.3 | £77 |
Cairn Energy | 1.5 | £67 |
Vedanta
(LSE: VED)
| 2 | £50 |
In your own portfolio you would aim for the same volatility in Pounds for each holding. The weighting is 1/beta.
A weakness of this method is that beta is not the same as risk, contrary to believers in Efficient Market Theory. Another is that beta varies every time you measure it, and the period over which it measured is somewhat arbitrary. It's only a best guess at future volatility. If a stock's recent beta seems obviously anomalous (and it often is) , just take a guess. Most will be in the range 0.5 to 2.
Three beds to lie in
Like Goldilocks you are faced with a choice of three ways to rest easy. I tend to use the risk weighting that I outlined in Part I, plus I do pile in when I feel very confident. Whatever you do, be sure it allows you to sleep at night.
Alun owns shares in Vedanta
More: Beta data from Bloomberg e.g. for ARM. Yahoo Finance also has beta data e.g. for ARM. The figures differ due to beta being measured over different periods.
