I was just updating my post on the merits of good asset allocation rules here when I got to thinking about how I should perhaps try to construct some rules around diversifying one’s risk within a portfolio. Of course there are different ways to measure one’s “mix”, whether it be in terms of sector or size or growth prospects, and I used to favour a mix around “growth-leverage-assets”, so my portfolio would contain companies which are growing fast, some which are cash rich and enjoy low leverage and some which have valuable assets.
However lately I have been turned onto a slightly different set of measures around “profit-sales-asset/equity” (read about it here). Financial analysts will identify this as a “DuPont analysis”, which is just a way of breaking down a company’s ROE into these components to find out more the nature of a company’s profits. Unfortunately this does not take the historical rate of a company’s growth nor the stock sector into account so I won’t be using it as a basis of my portfolio equity allocation rules. But it’s nonetheless an interesting exercise because it just shows that it’s not enough sometimes to simply be able to determine how good a company is, it’s just as important to determine whether it should go into my portfolio or not.
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