Position Sizing in Value Investing

Benjamin Graham — Warren Buffett's mentor — gave very specific instructions on capital distribution across grades of stock within a portfolio.

In the past, we have already seen the pros and cons of Diversification as described by Warren Buffett and his mentor Benjamin Graham (the founder of Value Investing).

In keeping with the philosophy of "adequate though not excessive diversification", Graham gave some very specific instructions on the subject of Position Sizing.

Defensive Grade Stocks

Graham recommended a minimum portfolio size of 10 for Defensive grade stocks; or in other words, not more than 10% of one's portfolio per Defensive grade stock.

"There should be adequate though not excessive diversification. This might mean a minimum of ten different issues and a maximum of about thirty."
Chapter 5: The Defensive Investor and Common Stocks, The Intelligent Investor

Enterprising Grade Stocks

In keeping with the same principle, Serenity recommends a portfolio size of 20 for Enterprising grade stocks; or in other words, not more than 5% of one's portfolio per Enterprising grade stock.

This is because Enterprising grade stocks have fewer qualitative requirements than Defensive grade stocks, but more than NCAV grade stocks.

Here's what Graham himself wrote for this category:

"If our winnowing approach had been applied to all 4,500 companies in the Stock Guide, and if the ratio for the first tenth had held good throughout, we would end up with about 150 companies meeting all six of our criteria of selection. The enterprising investor would then be able to follow his judgment—or his partialities and prejudices—in making a third selection of, say, one out of five in this ample list."
Chapter 15: Stock Selection for the Enterprising Investor, The Intelligent Investor

NCAV Grade Stocks

Graham also recommended a portfolio size of 30 for NCAV grade stocks; or in other words, not more than 3.3% of one's portfolio per NCAV grade stock.

"Buying 30 issues at a price less than their net-current-asset value... if one can acquire a diversified group of common stocks at a price less than the applicable net current assets alone—after deducting all prior claims, and counting as zero the fixed and other assets— the results should be quite satisfactory."
Chapter 15: Stock Selection for the Enterprising Investor, The Intelligent Investor

Example

So — as an example — one could distribute 100% of one's capital across five Defensive stocks (5x10%=50%), six Enterprising stocks (6x5%=30%), and six NCAV stocks (6x3.3%=20%)

Benjamin Graham's full stock selection framework includes detailed diversification recommendations for each category of stocks.

Graham Resources