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Zee,

To estimate your portfolio's weighted-average PIV-ER, add the market value for all your stocks to get your portfolio's market value. Then divide each stock's market value by portfolio market value to get each company's market value weighting to the total.

Let's say you have a $25,000 portfolio. Also, one of your companies is General Electric. If GE's market value in your portfolio is $5,000, then its weighting is 20% of the total.

Next, multiply each company's weighting by its respective PIV. Repeat for every company, then add all the weighted-average PIV's and you have your portfolio's weighted average PIV.

If you think General Electric has a PIV of 90%, then multiply its 20% weighting by its 90% PIV and you get its weighted-average PIV of 18%.

For simplicity, let's assume you have just one other company in your portfolio, Caterpillar. Its market value in your portfolio is $20,000, so its weighting is 80%. If CAT's PIV is 51%, then its weighted-average PIV is 41% (80% x 51%).

Add GE's weighted-average PIV of 18% to CAT's weighted-average PIV of 41% and you get your portfolio's weighted average PIV: 59%. The lower the PIV, the better.

When you base your portfolio PIV on market values, it matters a great deal whether 20% of your portfolio is in GE stock and the other 80% in CAT, or vice versa. With 20% of your portfolio in GE and the other 80% in CAT, your portfolio's weighted-average PIV is 59%, as we just learned. But if 80% of your portfolio is in GE and 20% is in CAT, then your portfolio's weighted-average PIV jumps to 82%.* Not good. So like I said, use a portfolio weighted-average PIV to account for companies that may dominate your portfolio.

(*To get 82% do this: (GE: 80% x 90% = 72%) + (CAT: 20% x 51% = 10%); 72% + 10% = 82%)

Repeat the steps above for ER.

I agree PIV-ER are not independent. But I also believe we need to think in terms of risk (what is my margin of safety if I am wrong?) as well as reward (what is my upside potential if I am right?). When you use PIV-ER, you help accomplish this goal. Of course, getting IV right is the whole ball of wax.

Thanks to TMF Slydo for his help.


Hewitt
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