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What Percentage Concentration Is Too Much in a Single Stock?

After a solid run higher, some individual stocks may grow to very large and concentrated positions in our portfolios. When that happens, is it a good idea to buy more? It depends on the company and how long a track record it has in delivering great investment returns. In this segment from "Beat & Raise" on Motley Fool Live recorded Oct. 5, Fool.com contributors Jason Hall, Brian Withers, and Nicholas Rossolillo weigh in on this type of situation.

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Jason Hall: We can actually wrap this around to the idea of thinking about earnings. Vihan is specifically using Upstart (NASDAQ: UPST) as an example. "If it grew from 5-8 percent of my portfolio, would I continue to add Upstart, make it significant or diversify across different investments?" I'll start with how I think about this. You directed it to me Vihan. What I tend to do with my position sizing is my position sizing in terms of whether or not I will buy more of the stock is, what percentage of my cost basis have I invested in the company? I don't really look so much at what size of my portfolio it is.

Obviously, when companies get to a certain threshold, that changes the game a little bit. But in general, because I do own a very diversified portfolio, it's over 130 separate stocks right now. Generally, my highest conviction ideas, I'm willing to invest up to two percent of my cost basis. If the stock is five percent of my portfolio, I love its prospects and I've only invested one percent of my cost basis, I'm absolutely comfortable adding more money to it. I'm also not quite 45, I've got 20 years to continue to invest for retirement, so 5-10 percent of my portfolio today is a very big different thing than five percent of my portfolio when I'm in Brian's situation, where I'm living half of my returns. I'm completely comfortable with that level today because I can grow into it by diversifying into other stocks and simply the performance of my other stocks, catching up overtime.

That's how I think about it. I'd love to hear you guys weighing on that too. Just in terms of thinking about it from a quarterly cadence, a company like Upstart, for example, sometimes they do tell you, "Hey, this is a company, maybe you do need to buy." A company reports 90 percent revenue growth on a business idea that you weren't sure if it was going to work, maybe they're saying, "Hey, yeah." Nick.

Nicholas Rossolillo: It depends on the company, I think. I also run a very diversified portfolio, not 130 individual stocks.

Hall: And growing...

Rossolillo: [laughs] It's certainly not super concentrated though either. Something gets about five percent, I start looking at the very least, diversifying by adding more to something else. But it does depend on the company. In my role as a professional money manager, I look at it not really like the money manager. I guess that's the business' job. That's why we invested, the business is managing our money. I'm more of the coach and what does a coach start with? Assessing the players and making sure the players perform well together, in the way that you'd expect.

It depends on where you're at, like you were saying, Jason, where you're at and what you're trying to accomplish with your investments that's really important. If you're trying to maximize growth and get every shred of return that you can. Maybe approaching a double-digit percentage of your portfolio in a company like Upstart makes sense, but maybe it doesn't. You have to be your own financial coach, and remember that your stocks, the businesses that you have vested interests in are players. How do these players affect your portfolio and the outcome that you're trying to achieve?

Hall: Brian.

Brian Withers: Yeah. I own 20 stocks and I only have three that are more than eight percent of my portfolio.

Hall: That means at least one or two are probably pretty substantial sizes.

Withers: Yeah. MercadoLibre (NASDAQ: MELI) is the biggest with 14 percent, Shopify (NYSE: SHOP) with 12, and Atlassian (NASDAQ: TEAM) with eight. From MercadoLibre's point, I've owned it for eight years. Wrapping this into our quarterly earnings call, I've had a chance to listen if I wanted to or read up on 32 different report cards from MercadoLibre. Is the 33rd going to make a big difference for me one way or the other for MercadoLibre? Not really. They built a really great reputation with me.

I love Nick's thought about the coach. MercadoLibre is one of my star players, one of my go-to's, ones that I'm going to put the ball in their hands with two seconds left and let them try and win the game. If Upstart is that for you and I think it would be really hard for Upstart to be that for you. Let me tell you why, they've been public for one year, not even a year. How many quarterly reports have you gotten to listen to? I'm not saying don't add to it.

I have 20 stocks and so my average holding is five percent. So already eight percent is already in the upper tier of the number of stocks in my portfolio. I do look at the cost basis that I add, but I also look at what is the average over all of those and make decisions accordingly, and I'll think about things in thirds. I'll move people up from the C team to the B team to the A team. I love this coach.

Rossolillo: I love what you just said too, Brian. MercadoLibre is your star player, but it took time for it to earn that status. Yeah. How many seasons was it before Michael Jordan won his first championship? Seven seasons? Yeah, I felt that really disturbing actually last year during the pandemic. I think a lot of new investors piled in substantial amount of their net worth into a stock or two that's pretty new, not a very long track record as a public company, but the company was reporting triple-digit sales growth. That's fantastic. It could be an indication that this company is going to do great things over time. But you have to let the company prove it. One quarter or one year of performance doesn't mean, "Okay, this is now my star player." There's too many good companies out there to say that.

Hall: Yeah. It's funny, because I think it in a way, we think of Brian's portfolio as being concentrated and mine being very diversified. There's 5,000 stocks that trade on US markets. [laughs] I have a very concentrated portfolio. [laughs] I own maybe 26 percent of the number of stocks that are in the S&P 500. That's concentrated.

I wanted to just touch on MercadoLibre real quickly too because that's still my largest individual stock and my cost basis is still my one percent. Guess what? I have a lot of faith. This is a business that's worth less than $100 billion, around $100 billion in market cap today. Do I think it can be a $500 billion company? Yeah, absolutely. I do over the next 15 years. Do I think it will be a trillion-dollar company? Maybe. Do I think it can beat the market over the next 20 years? Absolutely.

I think the point is that quarterly cadence can help you learn more about the business and think about your individual situation when deciding the sizing of an investment, whether or not it makes sense to you and whether or not you have enough conviction in that business to add to it, or are there other stocks as you should add to for a variety of reasons.

Brian Withers owns shares of Atlassian, MercadoLibre, and Shopify. Jason Hall owns shares of Atlassian, MercadoLibre, and Shopify. Nicholas Rossolillo and his clients own shares of Shopify and Upstart Holdings, Inc. The Motley Fool owns shares of and recommends Atlassian, MercadoLibre, Shopify, and Upstart Holdings, Inc. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify and short January 2023 $1,160 calls on Shopify. The Motley Fool has a disclosure policy.


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