How Many Stocks Should You Own?

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Feb 03, 2012, 09:30 ET

CHICAGO, Feb. 3, 2012 /PRNewswire/ -- Zacks Investment Research presents their newest list of stocks featured in their weekly Research Wizard article, which describes how to profit from stock market opportunities. The ideas in this article focus on 5 highly rated and stable stocks to add to your portfolio. Stocks include: Pfizer, Inc. (PFE), The Kroger Company (KR), Humana Inc. (HUM), Biogen Idec Inc. (BIIB) and Amgen Inc. (AMGN).

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Here are highlights from our most recent Research Wizard feature:

How Many Stocks Should You Own?

Last Friday through Sunday was just about perfect for me. I had some really fun time with family and friends, coached a youth soccer game, and got the chance to play soccer, tennis and the djembe drum. The best part about it was that little was planned in advance; it just kind of happened. Spontaneous fun is usually the best kind. Needless to say, my head was in the clouds on the train ride into work on Monday. Once the market opened, however, the grim realities of stock investing began to settle in. Don't get me wrong…I'm resilient. I understand and accept the ups and downs of life--and the market. But as a thinking man, the market drawdown made me wonder how I could protect my portfolio or reduce its exposure to risk. I then asked myself, "How many stocks should I have in my portfolio to reduce volatility as much as reasonably possible?"

I have a general idea of the answer to that question, but I've never actually completed a study to pinpoint the exact number. In my last article, I mentioned 5 stocks for the short-term and in the article prior to that, I listed 12 stocks for the longer-term. So, in general, are five stocks enough for a portfolio? Do 12 significantly reduce volatility? Is it better to even have more?

Since it's still fresh in my mind, I'm going to use last week's momentum screen and vary the number of holdings to get a handle on portfolio volatility. (For more momentum ideas, click here.) I'll be using our Research Wizard platform for this study so you can see the additional benefits and capabilities of this powerful tool.

I adjusted the screen so that it held just one stock each period then ran a test to see what the annualized volatility was. I then increased the number of stocks (equally weighted) by one, retested, and collected data for the graph below.

This graph shows that the more stocks you have in your portfolio, the less annualized volatility you should expect. For example, a one-stock portfolio had an annualized volatility of 66%, while a nine-stock portfolio had a 30% annualized volatility. What is annual volatility, you ask? Well it kind of defines the range of returns you could expect from a strategy in a given year. Here's more detail: if you owned this nine-stock strategy with a 20% average annual return and 30% annual volatility, then in two-thirds of the years, you should expect portfolio returns anywhere between -10% and +50%. (For the two-thirds timeframe, you simply take the return and plus or minus the volatility.) So what happens the other one-third of the time? Well, you could expect it to be outside of the -10% to +50% range. So you can see that low volatility is a very good thing.

Looking at the graph, you can also see that one-, two- and three-stock portfolios are highly volatile. It flattens out more and more as you add stocks. I only tested up to 20 stocks because it just inches down after 20. The S&P 500 had an annual volatility of about 20% with 500 stocks. So you know the slope between 20 stocks and 500 is fairly low. The line really starts to flatten out around 10-12 stocks. So that's a pretty good recommended minimum and you could add from there if you'd like. Recall that this pertains to equally weighted portfolios. If you have a few stocks that dominate your holdings, obviously you'll need to add more.

Since I only provided five stocks in my last article, here's a way to collect an additional five that are highly rated, with good value and price momentum, and aren't as volatile as others:

First, start with only US common stocks.

Next, create a liquid, investible set of the stocks with the largest 500 market values and average daily trading volume ≥ to 100,000 shares (if there's not enough liquidity, it'll be hard for you to trade it).

Add two other filters by selecting those stocks with a Zacks Rank ≤ 3 and at least a Buy on the average broker rating. (Let's stick with only the best or moderately rated stocks.)

Select only those stocks with a beta ≤ to 1.2. (We're looking for stocks with low or moderate volatility.)

Select only those stocks with a price-to-sales ratio ≤ the industry median. (Lower means you want to pay less per unit of company revenue compared to industry peers.)

Choose only the top 20 stocks with the best 52 week price change. (We're looking for winning stocks over the last year.)

Pick the 5 with the best price change over the last 12 weeks. (We also want them to be doing well over the last 3 months.)

Here are five stocks using the above methodology (2/03/12):

PFE – Pfizer, Inc.

Pfizer, a biopharmaceutical company, offers prescription medicines for humans and animals worldwide. This company is big, stable and has a good pharmaceutical product mix. The earnings report this week was a mixed bag, but the stock price didn't move much. The stock remains a relative value compared to industry peers and it pays a good dividend to boot. This company is also rated a Strong Buy by brokerage analysts.

KR – The Kroger Company

Kroger, a Cincinnati-based company, operates as a retailer in the US, and manufactures and processes food for sale in its supermarkets. This company has an average broker rating and Zacks Rank of a "Buy" and its stock price remains attractive based on a 0.2 Price/Sales ratio compared to a P/S of 0.8 for industry peers. Kroger also just issued $450 MM in debt with a rather low coupon. That means the debt market is signaling the company is low risk.

HUM – Humana Inc.

This Louisville, Kentucky-based company is scheduled to report earnings on Feb 6 and is highly rated among Wall Street brokers and on the Zacks Rank. The stock price of this company has been simmering, yet the recent pullback offers a good buying opportunity. The company is also an excellent value based on its Price/Sales ratio, has good profitability relative to industry peers, and pays a dividend as well. Humana offers various health and supplemental benefit plans in the US.

BIIB – Biogen Idec Inc.

Biogen discovers, develops, manufactures, and markets therapeutics in areas of neurology, immunology, hemophilia, and oncology around the world. This company is rated as a "Buy" by Street analysts and has had a string of earnings surprises and estimate revisions. The stock of this company has seen a recent surge in price, yet still remains a good value based on its Price/Sales ratio. This company shines bright in a cloudy industry.

AMGN – Amgen Inc.

Amgen, a biotechnology medicines company, discovers, develops, manufactures, and markets human therapeutics based on advances in cellular and molecular biology for grievous illnesses primarily in the US. This company has experienced a number of upward estimate revisions over the last month which is the reason behind its Zacks Rank "Strong Buy" rating. This company looks good on numerous valuation measures and started paying a dividend in August. The company also has been buying back shares and I like a company that reeks of cash.

So take a look at these five stable, yet highly-rated stocks and see which ones are a good fit for your portfolio. If you'd like to unearth more, I encourage you to click here to learn more about the screening and backtesting power of a stock research system built for the individual investor. You'll be glad you did!

Hope your weekend is the best it could possibly be!

Click here to learn more about this stock research tool.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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