When I started this blog I tried to give every stock I buy a grade on a scale of one to ten. I was aiming to achieve multiple things with this. I wanted to allocate the most money to my best idea’s, it could provide guidance on what stocks to sell in the future if a really great opportunity would come along and it could keep myself honest: you can’t claim to be successful if you generate all your performance with your worst idea’s.
The approach soon proved a bit problematic though: reality is just a bit too nuanced to be able to simplify your conclusion to a single number, and a better idea doesn’t necessarily mean that I should buy a bigger position if it’s a high-return and high-risk kind of deal. After more thinking than healthy for something so simple as this I decided to basically keep the current system, but to make it very explicit that a higher rating does not have to imply a bigger position size or a higher expected return.
The rating I try to give stocks is my perceived ranking of the risk/reward ratio of the various ideas, so the highest rated stocks should provide the best risk adjusted returns. The idea’s with the lowest ranking would be the stocks I would be selling first if a better opportunity would come along. Sizing on the other hand is a function of both the attractiveness of the risk/reward ratio and the absolute amount of risk. I will try to tell in my posts if have an overweight, normal or underweight position.
I don’t intend to grade stocks that I do not buy: in most cases I do not do more research than necessary to conclude that it’s not very attractive, or it could be attractive but it’s just too hard for me to understand. In both cases a grade would mean little.
So conclusion with regards to the stock grades: it’s mostly going to be business as usual, but now their meaning and goal have been more clearly defined. It’s strictly to rank the attractiveness of my positions based on the perceived risk/reward ratio.
One change is the scale I’m going to use. Instead of a scale from one to ten I’m going to use a five star scale. I’m obviously never buying a stock when I think the idea is mediocre or average, so it’s pointless to have a whole range of numbers you never use. I will convert the ratings on my portfolio page to the new system.