What are 'high-conviction stocks' and why should investors follow them

NHPC shares have seen a remarkable surge of 10% within just two days following a rating upgrade from CLSA to a ‘high-conviction outperform’. The brokerage firm’s endorsement has fueled renewed investor confidence in the state-owned hydropower company, leading to increased buying activity. Similarly, Bandhan Bank, which had been underperforming for a while, saw a strong rebound of nearly 5% after CLSA also issued a high-conviction rating for the private sector lender. This demonstrates how brokerage recommendations can significantly influence stock prices, especially when backed by deep research and strong market fundamentals.

Understanding High-Conviction Stocks: What Sets Them Apart?

High-conviction stocks are those that fund managers, analysts, and seasoned investors strongly believe will generate superior returns over the long term. Unlike a diversified investment approach—where capital is spread across various stocks to reduce risk—high-conviction investing focuses on a select few companies that are expected to outperform based on rigorous research and analysis.

Such stocks are identified based on:

✔ Strong business fundamentals – Consistent revenue and profit growth, operational efficiency, and market leadership.

✔ Competitive advantage – A company’s ability to maintain or expand its market share against competitors.

✔ Industry trends – Favorable macroeconomic conditions, regulatory support, and technological advancements.

✔ Valuation metrics – Price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and dividend yield.

For instance, NHPC has strong growth potential given India’s push for renewable energy. Hydropower is expected to play a key role in the country’s energy transition, and CLSA’s upgrade likely reflects confidence in NHPC’s ability to benefit from government initiatives aimed at increasing clean energy production.

Why Investors Favor High-Conviction Stocks

Institutional investors, hedge funds, and mutual funds often allocate a significant portion of their portfolios to high-conviction stocks. The logic behind this strategy is simple: by concentrating on a few well-researched, high-potential stocks, investors can achieve superior returns compared to a broadly diversified portfolio. Some of the key advantages include:

📌 Higher potential returns – Since high-conviction stocks are chosen based on strong fundamental and technical analysis, they have the potential to outperform the broader market over time.

📌 Confidence in the investment thesis – Investors who select high-conviction stocks are usually well-informed and deeply researched, leading to greater conviction in holding the stock despite market fluctuations.

📌 Optimized capital allocation – Instead of spreading capital thinly across numerous stocks, investors focus on a handful of high-quality companies, ensuring better capital efficiency.

The Risks Involved: Should Retail Investors Adopt This Strategy?

Despite the attractive potential returns, high-conviction investing carries significant risks, particularly due to concentration. Unlike a well-diversified portfolio that can cushion against sector-specific downturns, a high-conviction portfolio is more vulnerable to sharp declines if a stock does not perform as expected.

Key risks include:

⚠ Higher volatility – Stocks with strong growth potential can also experience sharp price swings, making them riskier for short-term traders.

⚠ Limited diversification – A concentrated portfolio means that if one or two stocks underperform, the investor may suffer significant losses.

⚠ Market dependency – Even the best high-conviction stocks can be affected by broader market downturns, such as economic slowdowns, policy changes, or geopolitical issues.

For retail investors, high-conviction investing can be an effective strategy, but it should be balanced with diversification. While it is tempting to go all-in on a handful of promising stocks, maintaining some level of diversification helps mitigate risks while maximizing long-term returns.

Final Thoughts: How to Approach High-Conviction Investing

To successfully implement high-conviction investing, investors must:

🔹 Conduct thorough research – Analyze company fundamentals, financial statements, and industry trends before making investment decisions.

🔹 Stay patient and think long-term – High-conviction stocks often take years to generate the expected returns.

🔹 Monitor investments closely – Regularly track financial performance and market trends to ensure that the investment thesis remains valid.

🔹 Manage risk with diversification – While focusing on a few select stocks, investors should still avoid over-concentration in one sector or industry.

High-conviction investing offers a compelling opportunity for investors looking to generate above-average returns, but it requires a disciplined, research-driven approach. Whether it is NHPC, Bandhan Bank, or other promising stocks, making well-informed investment decisions is key to long-term wealth creation.