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Eliminate these seven "evils" while building an equity portfolio

Why you need an equity portfolio?ThinkStock Photos
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Why you need an equity portfolio?
Text: By Vikas V. Gupta|ET Contributor

Let the new year mark a new beginning for your equity portfolio, by cleansing it of all ‘evil’. If you don’t have a portfolio yet, this is a good time to start.

First, figure out why you need an equity portfolio. To build long-term wealth and expand your purchasing power over time, you need to invest in an asset class that will beat inflation and tax.

Equity is the only asset class which has a high likelihood of doing so.
An unstable business modelThinkStock Photos
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An unstable business model
Remember that when you buy a stock you are becoming a partner in the company. Ask the question: Does this company have a track record of stable and growing revenues and earnings? If it doesn’t, don’t invest in it. Congratulations! You have eliminated the first ‘evil’— an unstable business model.
A weak balance sheetThinkStock Photos
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A weak balance sheet
Highly leveraged companies are like asuras. The creditors of the company can take it over, and leave nothing for the shareholders.

To spot such a company, look at the debt to equity ratio. If it is higher than 50%, the debt holders own more assets in the company than the equity holders.

If you decide not to invest in it, congratulations! You have eliminated the second evil—a weak balance sheet.
An incompetent managementThinkStock Photos
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An incompetent management
Companies which destroy shareholders’ capital are run by evil management. They might be very nice people, but as far as wealth and capital is concerned, they are evil.

To spot such a company, look at its historical return on equity. Is it lower than 15% and has remained low for several years? If you decide not to invest in it, congratulations again! You have eliminated the third evil—an incompetent management.
Paying too much for a great companyThinkStock Photos
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Paying too much for a great company
Be extra cautious. There is one more evil which destroys wealth and you must protect your portfolio from it. If a company is overvalued, it has a high likelihood of destroying wealth.

Is the stock trading at PE ratio greater than 30? If you decided not invest in it, congratulations! You have eliminated the fourth evil— paying too much for a great company.
HyperconcentrationThinkStock Photos
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Hyperconcentration
Does your portfolio have less than three sectors and fewer than 10 stocks? If so, go ahead and add one or two new sectors and more stocks.

Congratulations! You have eliminated the fifth evil— hyperconcentration.
High transaction costs and taxesThinkStock Photos
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High transaction costs and taxes
If you hold your positions for around a year and don’t trade too much during the year, you will successfully eliminate the sixth evil and seventh evils—high transaction costs and taxes.

(The author is CEO & Chief Investment Strategist, OmniScience Capital)

Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.
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