Spread Betting - Selecting Shares: Low or High Priced? Buy One or Many?

Q. Is it best to invest in high or low priced shares?

Assuming that the share is a reasonable investment, then for a given pot of money invested, is it better to concentrate on investing in a lower price share or a higher priced share?

A: In general it makes no difference what the ticket price is. Buying into a company whose share price is 220p is not inherently more sensible or less sensible than buying into a company whose shares are 660p. (On occasions a company will split its share price into smaller units anyway - or consolidate them into fewer at a higher price - and it's still the same company with the same prospects). Percentage movement generally applies.

There are perhaps a few exceptions to that generalization though. One of the reasons a company will bother to split or consolidate its shares is to improve the marketability of them. Doubling the quantity in circulation by halving the price can draw a greater number of people in the trading of them - and livening up the trade in that way can sometimes generate more competitive pricing activity. So if those 220p shares were actually 660p shares that have been split, they might arguably be a better play than a similar company at a similar £6-£7 share price who chose not to split. But that's probably more relevant to traders than investors.

Management who move into a company whose share price is way down in pennyshare land might wish to enhance the image of the company (and bring it onto the radar screen of fund managers who shun penny shares) by consolidating at a higher price. So there is some acknowledgment that ticket price does mean something to many prospective investors... psychologically at least.

In the USA, there is less inclination to split share prices - and some become huge over time. So a bigger ticket price might tend to indicate a long running company. But it's not so clear-cut in the UK with all this chopping and changing. Some firms split their price frequently. So it gets a bit silly trying to read anything into the current ticket price, as regards company status. And for any shares priced at over a quid or under twenty quid the arithmetic makes no difference in trading costs. Though it probably does at the extreme ends of the price spectrum.

FTSE-100 stocks at present range between £1 and £33 per share. AIM stocks anywhere between 0.25p and £288 each.

Q. Buying many shares - is it more worthwhile having my fingers in as many pies?

A: Yes, many shares, may sound like a cliche but do diversify! Unless you really know plenty about the ventures you are investing in, diversification is important. And regardless of how well thought out and well researched an investment is, there is always a risk that something could go wrong due to an unforseen, external event such as a natural disaster or market crash. Such events have the tendency to hit out suddenly and may inflict serious damage to an investor. Warren Buffett was once quoted as saying that he can't predict the economy, but he does know that a particular company is making lots of cash and is cheap on a 5-year perspective. What you want are investments that are not strongly positively correlated or maybe even negatively correlated so you can hedge against losses elsewhere... For instance a stock market crash is likely to see a jump in more risk-averse and stable assets such as bonds while a hurricance might be bad for insurance stocks but the price of oil (and related stocks) may rally if the affected area happens to be a major production site. The more stocks in a portfolio the less volatility it is likely to have - hence smaller % drawdowns on market corrections and profit warnings...etc

Let's take an example:

Oil explorers are, by their very nature, risky enterprises to invest in. If they find oil, their share price can rocket; if they don't, then they have some very expensive holes in the ground to show for their endeavours.

Scenario 1

You come across a company that is about to drill a prospect that has a 50% chance of success and, if successful, will lead to a ten-fold price rise. If the well is unsuccessful, the price will fall. The company will spend half its available capital on the well. So, a potential ten-fold increase, against a potential 50% fall (in broad-brush terms).

You decide to invest and the well is a duster. Was the decision a mistake?

Scenario 2

You come across ten companies, each of which is about to drill prospects (one each), each of which has a 50%* chance of success and, if successful, will lead to a ten-fold price rise. Each company will spend half its available capital on their well. Again, potential ten-fold increases, against a potential 50% falls.

You decide to invest in all of them. 50%* of the wells are successful and the share prices respond as predicted.

Overall you make a thumping profit.

Were the investments in those with failed wells mistakes? What about those with the successes?

Remember though that an increased number of holdings = increased transaction costs that will eat in to any profits if you are only dealing in small amounts (this is where spread betting helps as transaction costs are kept low!). Diversification is even more important for long-term investors who need to position their portfolios to account for a range of eventualities. How do you diversify? Diversifying implies buying into uncorrelated assets but your age also comes into play here - for instance one investing rule (known as the 'Rule of 100') advocates that you should take 100 and substract your age from it, with the result representing the maximum percentage of your portfolio which should be invested in higher-risk assets such as shares or commodities as opposed to bonds or cash.

Standard investment advice advocates that long term holders should diversify across a mix of shares, bonds, and money market funds. If you are like most people you will invest part of your money aggressively in stocks and shares, and part conservatively in money market funds like ETFs and bond funds. However, some young people will go 'all in' on stocks, and some very conservative people will go all money markets.

Q. But what proportion of your portfolio would you allocate to just one share? Is it just about your attitude to risk, or would you cut a position if a single share grew to be above a certain percentage of your portfolio?

Is it just about your attitude to risk, or would you cut a position if a single share grew to be above a certain percentage of your portfolio? The reason I ask is because one of my stocks, (DIA as it happens) after its recent rise accounted for more than 10% of my portfolio. Would you consider this to be too much and top-slice or would you feel that 10% - 12% was a reasonable amount. I did actually cut my position, even though I really like the stock, but I've been caught like this before, CHNS is a recent one that still haunts me. Any and all opinions greatly received, I need all the help I can get.

A: 10% means that 10 bust companies would wipe you out; you would be safer with 20 companies. What you have to accept is the fewer companies you have, the more volatility you get. There are many who pile in to just a handful of shares, but I like to sleep at night :)

It also depends what you trade... trading penny shares and speculative punts in mining and oil companies will get you your fair share of losing trades. If you are new to trading I suggest paper trading for say 6 months and in that time read up on a handful of select books. I decide the proportion depending on how confident I am with the stock, this can vary depending on lots of things, time of day, news coming out, when reports are due, general feelings in and about the market, and of course my mood!

It also has to depend on the stock, I hold DIA (got back in after a recent sale), so I quite like them (and don't consider them a company likely to go bust anytime soon - otherwise I wouldn't have bought because I hope I have now learnt that lesson) - but if you buy far too many of a company that's not liquid enough you could have trouble selling your shares should something negative happen and you wanted to get out fast.

Are you new to trading? If so, read the books and learn as much as you can before putting too much money into any one company and ALWAYS do your research, just five minutes spent looking for a little financial information can save you a lot of money (I wish I knew that before I bought the one that went bust on me)!!! Unfortunately, unexperienced trading can be very dangerous. And I think that at the beginning, anything is possible.

Having said that spreading yourself across 10 companies might be okay if you are disciplined with stops and you avoid non-profitable making speculative companies - never keep hold onto a losing position, at the worst after a 30% profit warning get out (or you might go all the way watching it go into bankruptcy). Supposing that in the very unlikely event that all of our ten companies overnight have a profit warning and drop 30% the next day. Your portfolio is down 30%. It's a big ouch but not the end of the world and far from wipe out. A 30% drop is recoverable. If you search out companies with good historical growth and low debt as your first criteria you should be on fairly safe ground with 10 companies. I personally prefer about 20 as a means of reducing drawdown volatility. Do keep in mind however that the more positions you have, the more you have to keep track of. I think it is better to have fewer positions that you can really monitor properly than more than you can realistically keep on top of - otherwise you can get caught out. Another thing to consider concerns the merits of checking low beta/high beta shares. So if you've a portfolio of 10 high beta mining shares you're going to be in for a rocky ride - not for me - but a blend of high and low beta shares is worth considering.

I think Jim Slater recommends holding about 8 shares only (memory might be dodgy here) but I've read others who say similar. I think Buffett too on the basis that there is a limit to the number of companies that he can know very well. I think that's one of the keys..get to know them really well not just superficially. It's easy to spread yourself too thinly as other trader/investors often with the best of intentions voice their enthusiasm for one share or another. Before you know you have ten monitor lists with a 100 shares on each and no clue what is going on. I've been reading the 80/20 principle too which comes to the same conclusion albeit from a different direction. I suspect the old cliche of building a fully diversified portfolio is just another way of ensuring average performance.

 ...Continues here - Researching Stocks and Shares

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