Categorizing Your Portfolio

I have 1 stalwart, 3 fast growers, 3 turnarounds and 1 cyclical.

For those who have read One Up On Wall Street by Peter Lynch, you’ll know that I’m referring to the 6 categories that he assigns to the companies in his portfolio. As I was reading this section, I had never thought about classifying my positions in terms of growth and return potential. I always looked at the different industries that made up my portfolio and it was refreshing to see it another way.

Let me briefly go through the 6 different categories he discusses in his book.

The Slow Growers

These are the large (although not always), saturated or aging companies that are not expected to grow any faster than your fingernails. They generate more cash than they can spend (I’m sure every wife dreams of a husband like this). Examples include the electric utility and waste companies such as AW, NU and CPK. Even Coca Cola (KO) could be considered as a slow grower. One way to determine a slow grower is by their consistent and increasing dividends or even more easily by their historical charts which shows a flat line.

The Stalwarts

These companies aren’t slow growers, but don’t expect it to grow fast enough to give you 100% gains within 2 years or so. Such companies like Adobe, Home Depot and American Express may be able to provide 15-20% per year depending on when and what price you pay for them but anything beyond those rough numbers is an additional bonus.

Stalwarts can provide outstanding opportunities when it is cheap enough because the company has already established itself yet still has growth potential remaining.

Lynch mentions that he keeps a few stalwarts in his portfolio as they are a good protection during recessions and corrections but they are also one of the first to be sold when a new idea comes up.

After reviewing my past sell and purchase patterns, it too seems like my stalwarts have been the first to be replaced when either a better stalwart or faster growth company appears.

The Fast Growers

The companies that grow aggressively and often have growing pains, yet provide the best opportunities for individual investors before Wall Street comes along. There are thousands and thousands of people who knew about Wal-Mart before it became the monster it is now. There are just as many people who knew about the growth potential of Hansen Natural.

Along with growing quickly, comes the added risk these young companies will end up in bankruptcy or the company may grow tired or out of ideas and turn into a slow grower.

The Cyclicals

Up and down, up and down. Fashion, oil, auto industries are a few examples of cyclical industries. There is usually a predictable pattern of high and low sales. Retail sales are highest during the Christmas shopping season and people usually don’t buy a new car every year. They tend to wait a few years or wait until the economy gets better before making purchases. Even airlines are cyclical because people tend to travel more during the summer, hence the peak and off peak rates.

Lynch informs the reader that too many people label cyclicals incorrectly. An example is Ford and GM. Just because these are established “blue chip” companies, many people expect it to act like a JNJ. Looking at the past shows that the graph is more like a moguls course.

The Turnarounds

A majority of what value investors would invest in. Depressed, beaten and oversold companies rebound to its intrinsic value and beyond very quickly once people realize that the company has been successful in turning itself around. The risk is that turnarounds don’t always happen, and companies end up using all of their cash and they are either back to where they started or worse.

Many companies try to turn itself around by diversifying into other unrelated fields of business just for the sake of trying something. Beware of these companies.

On the other hand, Apple has transformed itself from a successful turnaround to a fast grower. They’ve gone from a mediocre computer company to a killer consumer electronics company.

The Asset Plays

An asset play is where the company owns something much more valuable than just its business. The company may own land where oil lies just beneath or it may hold huge amounts of real estate that has been depreciated in the books for so many years that it doesn’t reflect the true value of the company like Sears. It could also be a huge pile of cash sitting around like Berkshire. Spectrum in the telecommunication and media business is an expensive and desired asset as it can give growth potential, monopolies and can also be resold for millions of dollars.

For asset plays to work out, a great deal of patience is required before the market wakes up.

Portfolio Management

I’ve only assigned one category to one company but there are companies that could be a combination. You could even go further and create your own categories.

Looking at my portfolio it seems like I may have one too many turnarounds, but overall, I’m happy with how my portfolio falls into the criterias. It’s a good reflection of my investing style and strategy.

So there is a brief outline of the 6 categories, but for additional topics in an entertaining and good read, you can read it for yourself by purchasing it here.

Disclosure

No positions held in any stocks mentioned.

[tags]asset allocation, portfolio[/tags]