The latest posts tagged with investingFriday — January 20, 2012
The pickle jar, as far back as I can remember, sat on the floor beside the
dresser in my parents’ bedroom.
When he got ready for bed, Dad would empty his pockets and toss his
coins into the jar.
As a small boy, I was always fascinated at the sounds the coins made as
they were dropped into the jar.
They landed with a merry jingle when the jar was almost empty. Then the
tones gradually muted to a dull thud as the jar was filled.
I used to squat on the floor in front of the jar to admire the copper
and silver circles that glinted like a pirate’s treasure when the sun
poured through the bedroom window. When the Jar was filled, Dad would
sit at the kitchen table and roll the coins Before taking them to the
Taking the coins to the bank was always a big production.
Stacked neatly in a small cardboard box, the coins were placed between
Dad and me on the seat of his old truck.
Each and every time, as we drove to the bank, Dad would look at me
hopefully. ‘Those coins are going to keep you out of the textile mill,
son. You’re going to do better than me. This old mill town’s not going
to hold you back.’
Also, each and every time, as he slid the box of rolled coins across the
counter at the bank toward the cashier, he would grin proudly. ‘These
are for my son’s college fund. He’ll never work at the mill all his life
We would always celebrate each deposit by stopping for an ice cream
cone. I always got chocolate. Dad always got vanilla. When the clerk at
the ice cream parlor handed Dad his change, he would show me the few
coins nestled in his palm. ‘When we get home, we’ll start filling the
jar again.’ He always let me drop the first coins into the empty jar. As
they rattled around with a brief, happy jingle, we grinned at each
‘You’ll get to college on pennies, nickels, dimes and quarters,’ he
said. ‘But you’ll get there; I’ll see to that.’
No matter how rough things got at home, Dad continued to doggedly drop
his coins into the jar. Even the summer when Dad got laid off from the
mill, and Mama had to serve dried beans several times a week, not a
single dime was taken from the jar.
To the contrary, as Dad looked across the table at me, pouring catsup
over my beans to make them more palatable, he became more determined
than ever to make a way out for me ‘When you finish college, Son,’
he told me, his eyes glistening, ‘You’ll never have to eat beans again -
unless you want to.’
The years passed, and I finished college and took a job in another town.
Once, while visiting my parents, I used the phone in their bedroom, and
noticed that the pickle jar was gone. It had served its purpose and had
A lump rose in my throat as I stared at the spot beside the dresser
where the jar had always stood. My dad was a man of few words: he never
lectured me on the values of determination, perseverance, and faith. The
pickle jar had taught me all these virtues far more eloquently than the
most flowery of words could have done. When I married, I told my wife
Susan about the significant part the lowly pickle jar had played in my
life as a boy. In my mind, it defined, more than anything else, how much
my dad had loved me.
The first Christmas after our daughter Jessica was born, we spent the
holiday with my parents. After dinner, Mom and Dad sat next to each
other on the sofa, taking turns cuddling their first grandchild. Jessica
began to whimper softly, and Susan took her from Dad’s arms. ‘She
probably needs to be changed,’ she said, carrying the baby into my
parents’ bedroom to diaper her. When Susan came back into the living
room, there was a strange mist in her eyes.
She handed Jessica back to Dad before taking my hand and leading me into
the room. ‘Look,’ she said softly, her eyes directing me to a spot on
the floor beside the dresser.
To my amazement, there, as if it had never been removed, stood the old
pickle jar, the bottom already covered with coins. I walked over to the
pickle jar, dug down into my pocket, and pulled out a fistful of coins.
With a gamut of emotions choking me, I dropped the coins into the jar. I
looked up and saw that Dad, carrying Jessica, had slipped quietly into
the room. Our eyes locked, and I knew he was feeling the same emotions I
felt. Neither one of us could speak.
This truly touched my heart. Sometimes we are so busy adding up our
troubles that we forget to count our blessings. Never underestimate the
power of your actions.
With one small gesture you can change a person’s life, for better or for
worse, but you have to start now.
Here are my results for the stocks I picked in 2011. You could have definitely outperformed the market if you followed these picks.
1. EERG – I liked this junior oil stock back in April at $0.35. It was interesting to me because the merger would have pushed the share price higher. It was a little speculative, but it still paid off. Since the announcement the stock rose as high as $0.45. If you sold at the high point you would have had a return of 28.5%. It has also merged with American Eagle Energy, with the new symbol for the two companies being EERGD. The new stock currently trades at $1.35.
2. DCHAF/DSM – I picked this rare metal holding company stock back in May at $0.49. I liked it because it was essentially a mining company except it purchased rare earth metals instead of mining for them. With China announcing that it was going to decrease the amount of rare earth metals it exported (thus increasing the price of rare earth metals), DCHAF/DSM was a no brainer. The stock rose as high as $1.24. If you sold at the peak you would have a return of 153%! It currently trades at $0.53. With assets worth $1.47 a share, the stock is still a great buy at this price.
3. CTXIF – I announced this textile manufacturing stock back in July at $2.20. Since that time the stock rose to a high of $2.60, up 18%. I still love this company and expect it to do very well in the New Year. The stock’s current price is $2.17. It’s still a great buy, especially considering the Net Asset Value per share is $6.11, a conservative liquidating value of approximately $4.06 per share, and net working capital of almost $32 million. The company is also sitting on just over $5 million in cash, or $0.72 per share in cash. The company is continuing to grow very rapidly and since 2010 has acquired an additional yarn spinning factory to include in its operations. I strongly recommend everyone to look into CTXIF, as the company and its management are still grossly undervalued. Look for this stock to perform well as the company continues to expand. For further information check my other posts on CTXIF.
So 2011 was a good year, even with the market downturns which most people suffered from. Stay tuned for some more posts!
JustinG101 - Twitter
Right now, amidst the current uncertainty of America’s roller coaster of a market, there is a question that continues to grow in investors’ minds as each day passes. “Will the Federal Reserve step in?” As Bernanke’s speeches continue to give rise to the possibility of Federal Reserve intervention should the markets fall, I speak for value investors everywhere when I protest, “Please don’t.” Despite what Bernanke and countless other high ranking “officials” say, monetary stimulus and Fed intervention is not the answer, no matter how bearish the market becomes.
As most investors know, there is a growing propensity for the Fed to intervene in capital markets at the first signs of trouble, usually in the form of some sort of monetary injection or interest rate change. This type of intervention not only creates moral hazards by prolonging overvaluation, but it also encourages out-of-control market speculation where so called “investors” have nothing to worry about and are free to recklessly toss money around. Come September, let us all hope that Bernanke stays put and does not implement whatever tools he has up his sleeves.
Investing used to be a rich persons game, but by today’s standards anyone with a small sum of capital and/or virtually no knowledge can enter into the capital market. It is these people which give rise to both grossly overvalued securities when markets are high and absurdly undervalued securities when markets fall. It is foolish for the Fed to keep intervening for the simple sake of restoring investor confidence after the market dips. These dips are necessary as 1. They are a natural part of the business cycle and 2. They keep out those without the emotional fortitude to make it through any bearish times. To think that markets can continue to grow forever without any relapse is foolishly optimistic.
And yet these investors, nay, speculators, are continually saved by the Fed when they implement their monetary gimmicks such as economic stimuli and low interest rates. Thus, the speculator’s investments are saved (or not allowed to go below a certain level), creating a false sense of confidence and safety for speculators in the market. And this false sense of smarts is warranted, as they know that they cannot lose as long as the Fed continues to do what it always has: intervene.
When a child touches something hot for the first time do they not learn from that mistake? Yes it hurt, but it is necessary in order for some to learn from the mistakes they make. But now what if that child’s mother kept intervening in this natural part of growing up? What if mother continually stopped the child every time they tried to touch that open flame? Well, the obvious answer is that child would never learn.
By NOT letting these speculators get burned the Fed is creating toddlers with no regard whatsoever for the safety of their own principle, as there is always a safety net there to catch them no matter how speculative their “investments” are. Mother Bernanke, you must let these speculators get burned. You must stop coddling them! It is time to let the market grow up and take responsibility for the mistakes it makes!
The Fed needs to stop holding our hand all the time and let us grow up, or there will never be any long term progress in the market nor the overall economy. The tools that are used by the Federal Reserve create a market in which there is no punishment for failure and ultimately no learning from past mistakes, leading to a market which is unsustainable in the long run. If these speculative investors never learn their lesson they will continue to repeat the same mistakes over and over and over, and the Fed will continue to inject money over and over and over, creating a vicious cycle of quantitative easing where interest rates fall lower and lower and lower. But as we all know, interest rates can’t fall below zero, and inevitably they must rise. And that is where everyone will suffer, as inflation will become uncontrollable. Printing more money and changing interest rates isn’t going to work forever. Sometimes, Mother, it is better to rip the Band-Aid straight off instead of pulling it off slowly.
I hope Bernanke reads this and takes into consideration the consequences of what will happen if things continue to move along as they have before with the Fed continually intervening in markets affairs.
So to both Bernanke and the rest of the Federal Reserve, get out of the markets.
And please, stay out.
Now here is where things start to get a little muddled, because sometimes risk is related to return and sometimes it isn’t. However, this will correlate in whether the so called investor is investing or speculating. For clarities sake it should be noted that regardless of what security is being looked at, risk pertains to the level of safety which can be derived from the companies quantitative and qualitative aspects, and not from whether the security is simply a stock, bond, debenture or derivative.
INVESTING ISSSS A TRADE-OFF BETWEEN RISK AANNDD EXPECTEDDD REEETUUUURNN
The statement is saying that the higher the risk, the higher return. Remember when you were a little kid watching cartoons and when the characters got so angry that steam came out their ears? That’s me when I read that statement.
That statement is very far from the truth. Investing is NOT a trade-off between risk and expected return. In fact the opposite is true. Stocks and portfolios with lower risk tend to provide higher returns than stocks and portfolios that carry higher risk.
Furthermore, let’s clear up what risk SHOULD be defined as in the stock market. “Risk is based on the amount of research one is willing to put into ones portfolio.” And, ultimately, the higher the price paid for a stock, the higher the risk. Investors who gamble in the stock market are not investors; they are gamblers. So please do not confuse risk in the stock market with anything else that is outside of what I have just stated.
I would also like to point out here what the actual definition of investing is according to Benjamin Graham: “Investing is allocating capital into an operation that provides safety of principle (your money) while providing an adequate return.”
But let’s get back to the point. Let’s look at how this statement is far from true, and how MPT is seriously flawed in stating this.
It is actually very easy to prove how this point is flawed. All I would need to look at is the fund with the lowest possible risk and compare it with ANY other fund that offered even slightly higher risk (which would be all of them). It has been shown that over any large time period, lower risk funds actually produce greater gains than higher risk funds. The lowest risk funds in history are the index funds; the S&P 500, the DJIA, the Nasdaq, and the rest. Unsurprisingly, they outperform the vast majority of high risk funds over any large time period (5-10 years).
Taking large time periods into account, lower risk mutual funds only return (on average) between 2.5% and 3.7% annually, with the higher risk portfolios generating only 0.2% per year! If we even take a look at the performance of mutual funds just over the last year we find that the average return was only about 1%! If anyone can show me a high risk fund that has outperformed the market over a 10 year span I would love to hear from you.
So when does the higher risk pay off? I mean, with higher risk there should eventually be higher reward right? Well, obviously not. There can be the POTENTIAL for higher returns with higher risk in the short run, but nothing more. Even saying this we would be speculating a great deal, as some investors have a vastly different definition of risk than what we should use (other financial institutions assign a level of risk based on the standard deviation of the historical returns or average returns of a specific investment).
“Strike three! Yerrr ooutttt!”
Ready for the next blunder that Modern Portfolio Theory assumes? Are you?!?! Well get ready for the next big assumption that MPT makes which is……………………………
MARKETS ARRRRRRRE EFFICIENT
What this means in that in order for MPT to work the model assumes that markets are efficient, meaning (more or less) that at any given time the price of a stock reflects what a company is worth based on all readily available public information and that prices instantly change to reflect new public information. In very simple terms efficient markets are saying that the market is a weighing machine. Stock prices accurately reflect, at any given moment, what a company is worth.
What all investors need to understand is that the market is only a weighing machine (and only sometimes) in the long run. In the short run, it is a voting machine, and a poor voting machine at that. There will be all sorts of price discrepancies in the short run due to, overconfidence, overreaction, representative bias, information bias, and various other predictable human errors in reasoning and information processing.
And if markets were efficient there would be very little money to be made, as companies would never become undervalued nor overvalued. Furthermore there would be zero arbitrage opportunities (taking advantage of a price difference between two or more markets). But let’s look at some examples of a few market inefficiencies.
1. The 2000 – 2002 financial crisis. Things were going so well in the stock market before 2000. The market was reaching new highs and people were making money. But of course we know that the market was grossly overvalued at this point. By believing in this idea that markets are efficient, financial leaders were inconsiderate to the chronic underestimation of the dangers of asset bubbles breaking. This inevitably led to one of our great recessions as the market corrected itself.
2. Lululemon at its current price of around $60 is overvalued. It is currently trading at over 60X what it is earning. Meaning that for every dollar you put into it you will earn, as an owner of the business (in theory), less than two cents on that dollar. Even its price to book ratio is huge at about 20X, meaning that even if the company liquidated for every dollar that you put into it right now you would only get back about five cents! Now don’t get me wrong Lululemon is an amazing company, but the current price that some people are buying into it at right now is extremely overvalued. Its prospects and growth don’t even justify a price this high! Even the average price to earnings ratio for the industry is only about 27X!! So even if we use this average (although this is still very overvalued) it should be trading at about $25. But in my opinion that is still too high. $15 or $20 would be more understandable. There is no safety of principle with Lululemon at its current price, and if the market were efficient, the price of Lululemons stock would be much lower. (Please note that when I originally wrote this Lulu was trading at about $120, however recently they did a stock split so the share price is halved. The ratios are the same however.
3. China Linen Textile Industry at its current price of around 2.25 is disgustingly UNDERvalued. The company sells linen and yarn in China, and has both excellent management and fantastic prospects. What is more interesting to note is that it should be trading at about $18.00 based on a combination of it’s earning power, book value and intrinsic value. Even just using book value it should be abour $5.00, which still points to the idea that the company is undervalued (see my analysis on CTXIF for a plethora of information). Its current EPS for the first quarter of 2011 was a whopping $0.46! If the keep this rate up they should finish the year with an EPS of about 1.84. That means the P/E ratio is only 1.2X! This means that if you were to buy today you would make back (as an owner) more than half of your initial investment in one year. Furthermore, the company is poised for growth, as it plans to take over other companies in the surrounding area, and also receives some unique help from the Chinese government (again, see my analysis on CTXIF). So why the price discrepancy? Who knows?! ( Actually probably because there have been some fraud charges against a few Chinese companies). The point here is that the market is not efficient. If it were, this company would be trading at a price much higher than what it is currently trading at.
So there are three examples on how the market is not efficient. Obviously we would need only one to disprove this assumption, but three really drives the point home. And of course there are many other examples out there, but we’ll stick with these ones for now.
Strike two MPT. The second assumption that the market is efficient does not stand up for modern portfolio theory to work.
“Here batter batter! Swing batter batter!”
A friend of mine told me that I should look at the Modern Portfolio Theory (MPT) for some ideas on what to write about. Boy was he right. So this will be a 4 post series on MPT and the pitfalls of it. But first, what is MPT?
MPT is a theory of investment which attempts to maximize a portfolio’s expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. It is also a form of diversification (and you know how I feel about that (if not read my post on diversification)). MPT is best explained by using a mathematical model, which, in my own opinion, is a bunch of baloney. The only mathematics you need to evaluate companies or stocks is simple adding, subtracting, multiplication and division. That’s it. Now the model works in theory, but in the real world, where there are no save points, it doesn’t even come close to working. This is due to the FACT that it makes a few very grave assumptions. So part one of our journey through the pitfalls of MPT starts now with the assumption that………….
INVESTORS ARRRRRRRE RATIONAL
One of the assumptions that enables MPT to work (in theory) is that investors are rational. I find great difficulty in believing this to be true due to the simple fact that investors are not any different from other people. Investors are people; plain and simple. Now how many people do you know who are completely rational? Take a few pauses here to really think about that……………keep thinking……….
(Remember I don’t count)
Probably not that many right? And that is because the majority of people (please do not take offense here) are too emotionally driven to be rational.
So now how can investors be rational? Are they some sort of superior being that has evolved to totally abide by the rules of logic and circumstance and admonish most, if not all, of their emotionally weak mindset? Of course not. The majority of investors are not rational. They can be greedy, overzealous, and sometimes frightened when their favourite stock takes a plunge.
As an example let’s look back a few years at some irrational investors who were buying technology stocks. And remember any smart individual (who knows at least a little accounting) could see that the majority of “tech” stocks were grossly overvalued at this time, even though they were very popular.
1. In 1999, Alexander Cheung of (what once was) Monument Internet Fund, after earning 117.3% in the first 5 months of the year, claimed that his fund would gain 50% over the next three to five years and would achieve an annual average of 35% over the next twenty years. Now is he rational? Well, considering most of the fund’s portfolio was comprised of internet stocks which were grossly overvalued, I’d say no he isn’t rational. He got caught up in the market mayhem of internet stocks. Another point to look at is that the highest 20 year return for any mutual fund in history was about 25.8% per year (performed by the great Peter Lynch). Peter’s performance during that period turned $10,000 into more than $982,000, and yet Cheung was saying that he could turn it into over $4,000,000! Obviously that is ridiculously overoptimistic. And here is the point….investors bought it. These “rational” investors threw more than $100,000,000 into Cheungs fund over the next year. By the end of 2002, that $100,000,000 was worth about $20,000,000. A loss of 80%.
2. Alberto Vilar of Amerindo Technology Fund, after a whopping 249% return for 1999, ridiculed anyone who doubted that the internet was a perpetual money making machine: “If you’re out of this sector, you’re going to underperform. You’re in a horse and buggy, and I’m in a Porsche (personally I loled there). Clearly Mr. Vilar was not rational in saying this, as the backbone of the economy at the time was the brick and mortar companies (companies with tangible assets). So clearly this investor, who ran a multimillion dollar mutual fund, is not rational. To showcase this, if you had invested $10,000 at the end of 1999 you would have about $1,195 left by the end of 2002. Makes you sick doesn’t it?
3. James J. Cramer, a hedge fund manager, proclaimed in 2000 that Internet-related companies “are the only ones worth owning right now.” These “winners of the new world are the only ones that are going higher consistently in good days and bad.” Oh man. As with the above examples, he isn’t looking at what these companies are worth. He is looking at the price of the stock. Sorry James, you’re being branded as irrational. By year end 2002, one of the 10 companies in the fund went bankrupt, and a $10,000 investment would have shrunk to about $597.44. That is freaking scary. I’m not sure which new world James was referring to here….oh wait, an irrational world, where people pay for overvalued stocks that won’t make them any money.
The majority of investors are obviously not rational and as long as people are guided by their emotions they never will be.
Strike one MPT. Swing and a miss. The first assumption that investors are rational does not stand up for modern portfolio theory to work.
1. Focus on the Intrinsic Value of Companies – This is by far the most important rule for the value investor. Intrinsic value can be defined as “the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value.” Value investors look at the fundamentals of a company NOT THE TECHNICAL ASPECTS OF A STOCK. And as history has shown, value investors outperform technical traders in the long run. The key here is to buy stocks at levels that are below the level of intrinsic value for a particular company. This not only provides a margin of safety but also the opportunity for gains when the market corrects itself.
2. Practice Emotional Stability – You do not need to be overly intelligent to be a good investor, but you do need strong emotional intelligence. Very few investors have made substantial money by getting caught up in market “swings” (although there are many who have lost money). As a value investor you should already be buying a stock at a level that is below what the company is actually worth, so if the stock goes down, all that means is that you can now buy even more of this company at a better price! Do not sell just because the price has dipped if the price of a stock is still below the value of the company. On the other side of things, just because the price has gone up does not mean that you should sell! A value investor should only sell once the price of the stock has surpassed the value of the company, or if he has found a security that is much more attractive then the one he currently owns. So if the price has gone up but the price of the stock is still below the value of the company don’t sell! There is still some money to be made. If you don’t think you will be able to handle this don’t invest in the stock market. A great example of not having emotional control comes from “The Intelligent Investor” by Benjamin Graham. In the Spring of 1720, Sir Isaac Newton, one of the great geniuses of all time, sensed that the stock market was getting out of hand and dumped all of his South Sea Company stocks (one of the hottest stocks in England at the time). He pocketed a 100% gain totalling 7000 pounds. However, months later, by getting swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price, and subsequently lost about 20,000 pounds (which is over 3 million by today’s standards). Now Newton wasn’t an idiot, but he did not have the emotional discipline that is necessary to be an intelligent investor. So if you’ve failed so far, it’s not because you’re stupid (probably not anyway). It’s because you haven’t developed the emotional intelligence required to be a successful investor (or you are extremely unlucky). So control your actions! Sometimes it is better to be the wolf than to follow the sheep.
3. Avoid Permanent Losses – Investing is not just about making money, it’s also about not losing money. Enterprising value investors outperform the majority of other investors because they do not lose money. If an investment does not offer an adequate amount of safety of principle (i.e. buying below intrinsic value etc.) then it is not an investment. It is a speculative operation and must not be considered. Most other value investors will say that a true value investor is not concerned with outperforming benchmarks. However, taking my own little spin on things, I believe that over the long term an enterprising investor should use benchmarking tools (such as the performance of the market indexes) to evaluate their performance or else there really is no point in putting in the time and effort into researching companies, especially if you are not going to outperform the market in the long run.
4. Diversify Less – Today you will hear (from the majority of investors) that you must diversify. By now you should know that I’m not a fan of major diversification (check out my article on diversification) because if an investor is already using a value oriented approach to investing diversification will actually limit ones gains, as a value oriented approach already provides a margin of safety. There is no point in using two techniques which both provide greater safety. It’s like wearing two life-jackets when you go boating. One life jacket would suffice. SO I’m actually going to go AGAINST Benjamin Graham here and tell you to diversify less, but only if you are willing to put in the time and effort to research the companies that you invest in. If you’re not willing to put in the time and effort then yes, you should diversify. But as an enterprising investor, diversification will be a very small part of your vocabulary.
5. Continue to Learn – This is a no brainer. If you’re not willing to continue to learn then don’t become an enterprising investor. You are always going to need to learn about new industries and new companies. You’re going to do a ton of reading, especially on various company’s financial statements. And if you don’t understand something in them, then you’re going to have to figure that out. You’re going to lean about different industries and how they operate, what their average profit margin is, and any threats that may hinder the industry in the future. And you’re going to love every waking minute of it.
I had a little argument the other day with someone about diversification. Well not so much an argument but more of a debate. Now, I understand diversification and the reasons for why it is used, but I don’t think people realize that there are also some pitfalls that come with it. But let’s look at the positives first. Positives: 1. Safety – diversification “should” provide safety in that by being diversified there is greater probability that one’s portfolio will fail. I completely agree with this, however it must be clear on what being diversified means. It does not mean owning a bunch of different stocks that are all in the same industry. It means you need to own a mining industry stock, a tech stock, a clothing store stock etc. That is true diversification. Owning a large number of stocks in the same industry is not being diversified. FURTHERMORE, one should also have some bonds in their portfolio, for an extra level of safety and to be truly diversified. 2. Picking Winners – By owning more stocks you greatly increase your chances of picking the winners (whether you know what you’re doing or not doesn’t really matter). By picking the winners there is a greater chance that your portfolio will increase in value, and that these winners will offset any losers that are in the portfolio. Negatives: 1. Reduced Gains – for the enterprising investor who has a strong understanding of business and stocks should diversify less so as to increase the gains that are returned to him. By being diversified not only do you pick winners you also pick stocks that may not perform as well as others. This will actually decrease the amount that could have been owed to you as stocks that perform poorly will dilute the success of stocks that show a greater performance. 2. More Time and Effort – By not being diversified you must be willing to put in the time and effort into researching stocks. If you are not going to do this and are just going to pick stocks by guessing or basing valuations of companies by the price of their stock, then you definitely need to diversify. However, if you’re doing your homework, you can diversify much less. NOTE: Not diversifying does not mean that the level of risk increases. It simply means that you must put more time and effort into the stocks you choose. Personally I am against diversification. It dilutes the gains that I could have made, and there are too many people out there who simply throw the word “diversification” around to convince their customers that their investments are safe. I believe that there are too many Investment Advisors out there today don’t really know what they are doing, so they tell people “Pick X, Y, Z, P, and Q because I don’t really know what I’m doing. So if X and Y go down P and Q should go up, and vice versa. Oh and Z is there in case all the other ones fail.” If I wanted to gamble I would go to a casino. If we also look at some of the richest people in the world (Warren Buffet, Bill Gates etc.) we see that their holdings are not diversified. The majority of the stock that they own is in their respective companies. That is why they are wealthy. In sum, diversification can provide a larger degree of safety, but one should still learn everything about the stocks that they are investing in before they give the go-ahead. It should be used only if you are not an enterprising investor and do not have the time or effort to put into your portfolio. However, if you want to be wealthy, I advise against diversification. You’re definitely going to have to do your homework though. Thanks for reading! I’m still searching for another good stock to write about, so stay tuned for that!