Value Investing – Pools of Investments (Lesson 14)
Value investors utilize pools of similar companies all belonging to the same industry in order to reduce risk, create accurate buy/sell models and manage their portfolio of investments in their investment fund. It is essential that all potential investments in a pool have similar attributes including market capitalization, comparable operations, indistinguishable balance sheet relationships and reporting formats. As explained in Lesson 11, all the members of the pool should have similar key performance indicators.
It is impossible to single handily manage hundreds of potential investments and design/build a separate buy/sell model for each company. To simply and efficiently create an investment portfolio, value investors create a group of five to eight very similar companies in the same industry. This is referred to as a ‘Pool’. Since this pool is dedicated to a particular industry, the investor can appreciate the research and due diligence required to understand the industry’s terminology, operational standards and performance outcomes. It is the most efficient use of time.
Most value investors can only manage one or two pools of similar companies. However, one or two pools is insufficient to maximize a value investment portfolio. Thus, it is best to turn to a club whereby several pools are available to the investor. In effect, all club members share the knowledge of their own respective pool with other club members and this diversifies the portfolio for all members. When an opportunity arises, all members are alerted and the club is rewarded as all members benefit from participation.
This lesson explains the benefits of using pools of similar potential investments as a value investor. Pools reduce risk exposure due to the comprehensive understanding of the key performance indicators and industry standards learned from research work and review of multiple similar reports. Secondly, with this knowledge, value investors can create highly accurate intrinsic and market price models to set the buy/sell points for investment with each member of the pool. Another advantage pools of investments create is the ability to efficiently utilize time to update the models. This in turn, allows the investor to focus on properly carrying out the systematic buying and selling of stock to generate excellent returns.