Baron Small Cap

Occasionally people ask about individual equity portfolios, and I thought I'd write out how I have built mine.  This isn't a how to guide or any form of recommendation, hopefully there's something worthwhile for those interested in individual stock selection. The reason for the caveats is, frankly, I routinely violate every rule you'll find in most investing books.  I sell my winners, buy more of my losers, catch falling knives, don't follow trends, buy options and liberally buy securities on margin.  For each of those points, you can line up the PhD's and successful investors who have made great money writing how to not build a portfolio the way I do.  On the other hand, I have strict disciplines I adhere to which suit my strengths and weaknesses and I like to think there are some pretty smart investors that would grudgingly respect my plan. Basic Guidelines I am a value investor at heart, if I am not buying something below what I think its worth, I find it impossible to then plan what to do with the asset Dividends matter, dividends illustrate the management of the company at least vaguely remember they have shareholders All things being equal small is better than big All things being equal, foreign is better than US Diversification matters Love what you own, but you still have to pay attention to the overall environment Volatility is your friend, Risk needs to be accounted for and know the difference   How do I buy and sell? I always buy or sell in 1/3 increments.  Generally I will consider buying when a security is at a 25% discount to my opinion of fair value.  I use charts to help with timing and decision making.  I only buy what I'd like to own, which sounds stupid, but I'm not going to buy a company I wouldn't mind holding for a while.  When companies approach my fair value, if I own more than one increment, I will begin selling.  The plan is to keep the first bucket, unless something fundamentally changes with the company or valuation gets completely out of hand.  Over time, I build positions by selling slightly less than what I buy.  So if I buy 100 shares, when I sell, maybe I'll sell 75, unless I have something else I really want to use the funds on. The most important thing for me is to be happy with small wins and to not regret "leaving money on the table". How do I find stocks? My list is based on years of research and investing.  I use the Dividend Achievers and Dividend Aristocrats lists for ideas.  I also maintain a list of small cap mutual funds who's managers have a track record of success and adhering to an investment discipline I respect that I check in on their portfolio holdings occasionally (PNVDX, BSCFX , BCSIX, ICMAX, ORIGX, RYSEX, TASCX, WAAEX).  I never blindly follow their picks, but I use them to generate ideas of stocks to work up on my own. What's on my list? Information Software - ATVI Hardware - ATMI(x), LLTC(x), PKE(x) Media - Telecommunications - APSG   Services Health Care - NVS(xx), BDX(x), VIVO(x) Consumer Services - WM Business Services - NAT(x), ADP Financial Services - CIM(xx), SAN(x), USB(x) Manufacturing Consumer Goods - GLT(x), UVV(xx), GIS, MKC Industrial Materials - AGCO(x), CRS(x), CYD(x), FMC(x), NUE(xx), POT(x), TRN(x) Energy - CLB, ESV, MEOH(x), OXY, STO, XOM(x) Utilities   Gold - BVN   I also own some ETFs for diversification, all of them are international WisdomTree SmallCap Dividend ETFs (DFE, DFJ, DGS). Each ‘x' next to a symbol is the number of buckets of each security I currently own.  I have a few more on my watch list, and I am always on the lookout for companies to monitor.   According to M*, the style boxes for my portfolio are: 6-14-13 10-19-1 12-17-8 Price/Prospective Earnings 9.29 P/B 1.55 Projected EPS Growth 14.02% Yield 3.60%   Commissions, Fees and Margin I use Interactive Brokers because of their cost structure.  I pay about $12 per month for market data and then $1 per trade.  My margin rate is 1.7% annually.  This low margin rate allows for responsible use of margin to give me more capital to invest.  I won't make the case for or against margin here, because there are very good reasons to not buy on margin, but used responsibly, its tough to pass up 1.7% capital.    Hedging I've found, especially this year, sometimes the market is irrational on the upside.  As the market rises, typically I want to be selling into strength, but at times I want to keep what I own but still be able to express my skepticism for the overall market. I hedge by buying in the money SPY puts usually about two months out.  My goal is not to run a market neutral hedge fund, but instead to guard against loss of portfolio value when I have some conviction the market is going to fall.  I consider my portfolio much riskier with the S&P 500 at 1200 than at 1020. The great part of hedging, beyond the sleeping better at night part, is it provides ammunition to buy with as the market declines.  I lived through 2008, and there's no worse feeling than being a value investor that is out of cash because everything was such a great buy when the market 10% higher than it is now. I consider each put to represent $10k worth of market protection (a sophisticated options trader would poke holes in that assumption), and unless the market is severely undervalued in my opinion, I expect to usually have about a 1/3 hedge.  As the market rises to my opinion of fair value, I add to it.  Right now for example, I'd want to be fully hedged when the market was about 1140 or so. My hedging strategy is simple and inexact at best.  The general idea is to be more prepared for a market decline as the market rises, and use the proceeds from the hedge to buy when the market drops.  This means I'm going to underperform in a raging bull market; I felt like an idiot in mid-April, but losing less and not having to sell stocks I believe in makes it worth it to me.