Capital Allocation explained in easy way for your portfolio


I receive many emails from the readers of our blog to check their portfolio. I get amazed to see the list of stocks many of you own. The minimum number of stocks so far I have seen is 23 and maximum almost 55 stocks in the portfolio!

Professional investors who manage millions of rupees too stick in range of 25 – 30 stocks. I know you might point few who own 40 or even 50 stocks in their portfolio. The question I am asking is, do you really need to own those many stocks in the name of risk management?

I am completely against it. Even the research report says that after 20 stocks, your risk of portfolio falling down flattens. Means you will get similar results owning 50 stocks or 21 stocks in your portfolio.

So why do people invest in so many stocks? If you are one of them, I would like to know your side story.

To me it looks like less conviction in their research or you can say lack of research conducted before investing. Or it could be fear of losing or not participating in the rally that media or few pundits are talking about it these days.

Understanding risk


Before we go ahead let us understand the risk you take while investing in the stock market. This is very important to know so that you can mitigate this risk and diversify. So there are two types of risk you take while investing in the stock market.

  1. Market risk
  2. Specific risk

Market risk


As soon as you buy any stock, your portfolio is exposed to this risk. The worst part is that you cannot mitigate this risk. To avoid or control this risk, you have to come out or liquidate your portfolio. This risk is also known as systemic risk. Inflation, interest rates, all the lead economic indicators and government policies all of these drivers influences market. Also the countries social mood influences the market outcome.

Did it happened with you, that your research says that XYZ stock looks good opportunity to invest and you bought them and next day some negative macro-economic news dragged the stock price down by 10% in weeks’ time. The best live example to give you is Hindustan Zinc. We bought that stock on the 1st April and its stock price is down by almost 6% in months’ time! What changed is the expectation of zinc price this year!

Specific risk


Specific risk is the risk involved in the company you invested. This is the best time to notice the effects of specific risk (reporting season). Any good or bad news impacts directly to its stock price. Kitex Garment reported they will consider to give bonus and will also issue dividends when they report later this week resulted in its stock price to jump 20% in 3 days! Banks reporting higher NPA’s or provisions results into its stock price going down.

So when you hear the word diversification then understand that these professionals are talking about this specific risk.

Our framework


We cannot mitigate market risk entirely but we can manage completely specific risk involved in investing stocks. ‘Preservation of capital’ is our first goal and not the making of money. Because if we lose all our capital then there is no chance of making any money out of stock market.

So there are three simple steps that we ask investors to follow.

  1. Buy only quality companies
  2. Avoid bad companies
  3. Buy only when they are trading at cheap prices.

It sounds easy but needs lot of discipline to practice. And practice only can make you perfect.

Capital Allocation


If we give exactly same information of a company to 10 different people in the room and ask them to calculate its intrinsic value, you will get 10 different intrinsic value for the same business!

It is very hard to calculate future year’s intrinsic value as businesses are not static in nature. Profits change, dividend policy changes, bonuses, splits and many such things that impact its end intrinsic value. This is the reason we talk about intrinsic value band with you all.

Imagine ABC stock, whose next year expected intrinsic value band is in range of Rs 70 – Rs 100. The stock price is trading at Rs 90. If you are looking to invest Rs 1000 in that business, how much money will you invest at its current stock price of Rs 90? And how will you mitigate risk?

To answer those question first let us understand the valuation band. When we say intrinsic valuation band of Rs 70 – Rs 100, we mean the worst valuation that it can go down is Rs 70 and the best it can go up is Rs 100. In other words, you should sell this stock when it breaches Rs 100 and invest fully when its stock price is trading at or below Rs 70.

In the above example, we will invest only Rs 330 at stock price of Rs 90.

We advise retail investors to invest in 5 -12 stocks. If you follow our framework and swing your bat when you can hit six! Then you have technically mitigated both the risk!

We prefer to invest in 5 stocks with our model portfolio and we are happy to allocate not more than 20% of our entire portfolio in each stock. If we look at the above example then we are happy to invest only 33% of our 20% allocated individual stock or 6.6% of our entire portfolio with ABC stock.



If you follow our framework and capital allocation strategy you can completely mitigate your specific risk and manage to post better returns then the market in the long term. Your thought and ideas are most welcomed.