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One of the questions that comes up again and again here on Getquin is: When is the right time to buy? The discussion often revolves around valuations, historical multiples or possible setbacks. This perspective is understandable. At the same time, it often distracts from a decision that is at least as important for the risk of a portfolio: the position size.
Many losses do not occur because an idea was fundamentally wrong. They occur because a position was too large. Conversely, the opposite also happens. A good idea works, but is weighted so small that it has hardly any effect on the portfolio. It is therefore worth thinking not only about whether a company is interesting, but also about how much capital should be allocated to it in the first place.
The background is relatively simple. The future is uncertain. Companies can perform better or worse, markets can grow or stagnate, valuations can rise or fall. Forecasts usually try to predict a single future path. In practice, it often makes more sense to work with scenarios, i.e. several plausible developments.
This is exactly where the logic of position sizes begins.
Position values are essentially derived from two dimensions. Firstly, from the quality of a company. This includes competitive advantages, return on capital, market position and the stability of cash flows. Secondly, from the uncertainty of future developments. This can arise from technological changes, cyclical markets, regulatory risks or simply the size of a company.
The higher the quality and the more stable the business model, the larger a position can be in the portfolio. The more uncertain the possible future paths, the more cautious the weighting should be.
A small thought experiment illustrates this logic.
Assume a company is analyzed and three plausible scenarios for the next five years are defined.
In the bullish scenario, the company grows strongly, the valuation remains stable and the share price doubles. In the neutral scenario, the company grows moderately and the share price rises by around 40 percent. In the bearish scenario, growth is disappointing and the share price falls by around 30 percent.
If these scenarios are assigned probabilities of around 30 percent for the bullish scenario, 50 percent for the neutral scenario and 20 percent for the negative scenario, this results in an expected value.
30 percent times plus 100 percent
50 percent times plus 40 percent
20 percent times minus 30 percent
The weighted expected value is therefore approximately plus 44 percent over five years. That is attractive. Nevertheless, a high expected value does not automatically mean that a position should be large. The spread of possible outcomes is also crucial. An investment with high uncertainty typically has a lower weighting than a company with more stable cash flows and narrower scenarios.
In practice, this often results in three categories in the portfolio.
The first category is core positions. These are companies with structural competitive advantages, high returns on capital and relatively stable business models. An example of this is $GOOGL (-0,11%) (Alphabet). The company has dominant platforms in the search engine and advertising market as well as considerable economies of scale. Another example is $V (+0,84%) (Visa). The global payment network benefits from strong network effects, high margins and a business model that functions relatively independently of short-term economic fluctuations. Such companies can often achieve weightings of around five to ten percent in the portfolio.
The second category is satellite positions. These are usually smaller companies or companies with more volatile results whose business model nevertheless appears attractive. Examples of this could be $ERII (-1%) (Energy Recovery) or $EKT (-2,03%) (Energiekontor). Both benefit from structural trends such as water infrastructure or renewable energies, but are also subject to greater operational fluctuations than global platform companies. Typical weightings here are often in the range of two to five percent.
The third category is option positions. These are investments with very high uncertainty but potentially high upside. Commodity companies or very small growth companies often belong in this group. An example would be $DML (-2,9%) (Denison Mines) from the uranium sector. Such positions are often deliberately kept small, between half a percent and two percent of the portfolio. The idea behind this is simple. If the investment fails, the damage is limited. If the scenario works out, the contribution can still be relevant.
A concrete numerical example makes this logic more tangible. Let's assume a portfolio of 100,000 euros. A core position with an eight percent weighting then corresponds to around 8,000 euros. A satellite position with a weighting of three percent corresponds to around EUR 3,000. An option position with a weighting of one percent corresponds to around EUR 1,000. Even if such an option position fails completely, the effect on the overall portfolio remains manageable.
Another point is often underestimated. Position sizes are not static. They change automatically over time. If a share rises sharply, its weighting in the portfolio increases. Many of the biggest portfolio winners arise precisely because successful positions are not reduced too early.
An originally small position can become one of the largest positions in the portfolio over the years. This is not a mistake, but often a sign that a good idea has actually developed.
Conversely, it can make sense to reduce positions if valuations rise sharply or if the weighting has become disproportionately large due to price gains. The aim here is not to time short-term price movements. The aim is to maintain the stability of the portfolio architecture.
The most common mistake in this context is overconcentration. It is rarely the result of a consciously planned strategy. It is often the result of narratives. A convincing story, a phase of rapid price gains or strong attention can lead to individual positions being expanded further and further. This makes the portfolio more susceptible to errors.
The key insight is therefore relatively simple.
A robust portfolio is not created by timing every share perfectly. It is created by allocating capital sensibly according to quality, valuation and uncertainty.
Or to put it another way.
The entry determines the price.
The position size determines the risk.
The next article in the series therefore deals with a question that follows on directly from this. How do you actually deal with winners in the portfolio? When should a position simply be allowed to continue and when does a weighting become too large? An exciting example of this is $GOOGL (-0,11%) (Alphabet). A company that has achieved enormous increases in value over many years and at the same time repeatedly raises the question of how to deal sensibly with such winners in the portfolio. This is exactly what the next part will be about: Managing winners properly.
