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 analyse the factors like the business model, financial health of the sector i.e., the debt burden on the sectors, future opportunities.

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 analyse the companies operating in the industry and choose two stocks of each sector for diversification of your stock portfolio. You need to analyse the following factors.

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 increased 72% on year-on-year basis.

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.

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.