Cut the clutter: A step-by-step guide to trim your portfolio

Investors, be warned. Don't bite off more than you can chew. It is often easy to get carried away and, in the pursuit of diversification, end up with a portfolio too big to manage.

In fact, one of our more frequent queries from subscribers is how to declutter a portfolio. And yes, decluttering can be as taxing as going through page after page of annual reports. After all, we don't want to live with the regret that we let go of a multibagger just because we were trimming our portfolio.

So in that spirit, here are a few steps you can follow to exit from the potential duds cluttering your portfolio.

Step 1: Let the fundamentals guide you
When in doubt, always go back to the basics. Start by identifying companies that have been limping for quite some time. Remove companies with high debt (debt-to-equity of more than two), poor return on equity (five-year average of less than 12 per cent) and poor cash flow from operations (negative CFO in at least three out of the last five years).

Step 2: Stay in your comfort zone
Life begins out of the comfort zone, but not the returns. Once you have completed step one and let go of the underachievers, focus on the businesses you can understand. Understanding doesn't mean knowing the products and services it offers. If you do not have a clear picture of how a business operates, how it generates revenue, its target customer base and the shortfalls associated with the sector it operates in, it's time to let go.

Step 3: Future holds the key
Once you are done with steps one and two, it's time to look at what the future holds for your bets.

Ask yourself these questions when judging the future prospects of the remaining companies:

• Does the company have a moat (or competitive advantage)?
• Does the business have high capital requirements (both fixed and working capital)?
• Does the company have a high capital efficiency (i.e., a high ROCE)?
• What are the growth prospects?

This will help you identify companies that might have been good bets when you invested but don't have much to offer anymore.

Always remember, too much of anything is good for nothing. That goes for diversification too.

Suggested read: Declutter and consolidate your portfolio