Many people, even investors, are afraid of math … or at least uncomfortable with it. But myself, I’ve always liked math—there’s a certainty to it, and given that everything in the stock market is totally uncertain, it’s nice to be able to rely on a trusty partner.
(In fact, I actually was planning on getting a minor in math in college, and the first handful of classes—calculus one, two and three, etc.—were no problem. But I specifically remember, at the start of a semester, going to exactly two classes of Linear Algebra (whatever that is), listening to my professor teach for an hour, and having absolutely no idea what he was talking about. None. So I dropped the class and my minor the next day, and haven’t regretted it since.)
Luckily, any math needed for the stock market is basic stuff, and we all have calculators or spreadsheets that do the heavy lifting for us. Today, I want to touch on the four factors that affect your portfolio—they’re really the only four things that determine your portfolio’s return.
The first is the one that most people focus on: Your winning percentage, or what is often called your batting average. This is simply the number of winning trades versus the number of losing trades.
The second factor is routinely named your slugging percentage—that is, the average amount of money you make on your
winners, divided by the average amount of money you lose with your losers.
The third factor is something that few investors focus on, but actually has an outsized effect on your total return: your average position size (what percent of your portfolio you invest in each stock).
The last factor is simply your turnover—i.e., how many trades you make per year (or per quarter or per month).
Why write about these four factors? Because, if you’re striving to improve your results, these are really the only four things that move your performance. Think of them as levers—changing one up or down usually affects the others, and it has an effect on your performance.
For example, if you’re determined to have a very high batting average, the chances are you’re not going to take huge positions, and you’re also going to be taking a lot of quick, small profits … thus lessening your slugging percentage. Or, if you decide to constantly strive for big winners, you’re going to have to give your winners time to move up … thus decreasing your turnover.
Are any of these four factors more important than the others? Well, interestingly, most investors focus on their batting average; in fact, investors subconsciously work to not necessarily maximize profits, but to maximize the number of times they are right. That’s why so many investors are quick to sell winners and slow to sell losers (the wrong strategy with growth stocks).
Yet it turns out that your batting average is not overly important for your results, or at least, it’s not any more important than the other factors. Yes, if you’re only correct on 10% or 20% of your trades, you’re doing something wrong. But usually, any batting average above 40% should be good enough to produce profits for you.
As a growth stock investor, I would say the most important factors are going to be your slugging percentage and your position size. If you’re able to keep all your losers relatively small, yet hit on a few big winners each year, while at the same time having the courage to manage a concentrated portfolio (say, 8% to 12% of your portfolio in each position), you’ll be in position to make great money.
I really don’t have any specific conclusion on the best balance between these four factors because, well, there isn’t a perfect balance—as usual, it depends on what kind of investor you are and what your true goals are.
But the next time you’re sitting around looking for ways to improve your results, be sure to do some work ahead of time and determine your batting average, slugging percentage, average position size and turnover. Just examining these four metrics will help you spot the strengths and weaknesses in your investing practice, and hence, help you make more money.