The Key to Wealth in the Stock Market: Diversification or Concentration?
Updated: Jun 18, 2021
I hate portfolio diversification and I hate the way it is sold to clients of major brokerage firms and new investors. Yes, having 30-60 stocks in your portfolio will lower your portfolio risk, but it wont get you to where you want to be financially. The only person that benefits from you the investor owning 30-60 stocks is your broker.
For every stock you buy there's a commission, and every time you sell that’s another commission. And you can’t sell one without replacing it, so there is another buy and another commission. You the investor rack up commission charges, and what do you get? Underwhelming returns.
If you’ve been around investments and investors long enough you’ve heard that diversifying your portfolio is the key to success; or you’ve heard don’t put all of your eggs in one basket. Those sayings need to be updated. In today’s market, concentration is the key to wealth and investment success and you should put your eggs in as few baskets as possible.
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.” – Warren Buffett
And Warren Buffett put’s his money where his mouth is. Warren Buffett’s Berkshire Hathaway owns a number of insurance companies, GEICO being one of them.
(Of the 64 Berkshire Hathaway operating subsidiaries on this list, 11 of the companies are insurance companies)
Concentration over Diversification
It is better as investor to gain knowledge in a particular area or industry and concentrate your investment capital in the best company(s) of that industry or sector.
Wealth and investment success are gained by investment concentration. Holding a portfolio of small or large investments in 60 companies and watching 20 of them increase in value, 25 others stay stagnant, and the last 15 decrease in value is an easy way of getting you back to where you started, flat.
Over the past few years the market has provided investors with great companies trading at value prices, and not just any companies, we are talking about industry leaders.
In 2014 Apple was trading at under $100 after its stock split. In the same year Amazon was trading in the $290 range. When adjusted for its 7-to-1 stock split Netflix was trading at around $60 in the summer of 2014. Google was trading at under $600 per share around the same time, Facebook was around $70 per share, and Visa was around $40 per share.
Today, Apple sits just under $160 per share. Amazon is over $1000 per share, Netflix recently crossed $200 per share, Google is over $1000 per share, Facebook is trading at over $170 per share and Visa is over $105 per share.
Is this hindsight investing? Absolutely it is, but there is a point. Instead of allocating your money to 10 different positions, how much better would your portfolio be had you just put it all on one or two of the great companies above? What else were you buying in 2014? The stock of a company that is 5th in its industry, but has exciting new unproven technology? Investing can be risky but it isn’t gambling, building a solid position in Apple isn’t the same as betting it all on black and hoping for the best.
Now If you’re a small investor it would have been very difficult to build a position in all of the companies listed, but if you chose just one to put your money into you would be experiencing remarkable returns.
How The Seville Report Does it.
Today it’s about concentration, not diversification. Put your eggs in as few baskets as possible. At the Seville Report, each quarterly report has three to four companies that we’ve reviewed and have really broken down to find their value. Each company has a buy zone listed. The buy zone is the area where we will build our position.
Below is a chart of Trip Advisor (TRIP). We did a review on Trip Advisor in July, it graded out at a very low 'C', but we liked it. We set the buy zone between $35 and $40. You can see that the company left the buy zone, but has now retraced back into the zone.
Like any other investor we don’t mind when a stock we’ve isolated increases by 5% days after we purchased it, who doesn't love a quick 5%. But we really love when a stock stays in the zone and we’re able to accumulate more before it rises. We want all of our eggs in a good basket before the rise.
So this is for you, the guy and girl looking at 10 to 20 different companies, with a plan to buy a few shares every paycheck of 10 to 20 different companies in an attempt to be diversified. This is also for you, the Robinhood investor buying a share here and a share there of dozens of stocks. STOP NOW! Find your top three stocks out of the 20 you're thinking about, and set a buy zone for each, then accumulate shares while the stock price is in your buy zone, and wait for the ride.
The key to investment success is not diversification, it is concentration. Isolate good companies with stocks at value prices and build a position.