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Why I run a concentrated portfolio & a list of Special Opportunity Investments that I own



April 04, 2011 – Comments (6) | RELATED TICKERS: VOD , AWK , PWE

So I decided to re-read Joel Greenblatt's investnig classic "You Can Be a Stock Market Genius" this morning.  I read it a number of years ago and I can say that without a doubt it is the best book on investing that I have ever read.  I suppose that's why I like the Special Ops service so much.  The book is the unofficial guide to investing in special situations.

Anyhow in chapter one I came across a passage that relates to the portfolio size debate that we were having earlier in this thread.  Here's what the godfather of special situation investing has to say on the subject:

Statistics say that owning just two stocks eliminates 46 percent of the nonmarket risk of owning just one stock.  This type of risk is supposedly reduced by 72 percent with a four-stock portfolio, by 81 percent with eight stocks, 93 percent with 16 stocks, 96 percent with 32 stocks, and 99 percent with 500 stocks.  Without quibbling over the accuracy of these particular statistics, two things should eb remembered:

1.  After purchasing six or eight stocks in different industries, the benefit of adding even more stocks to your portfolio in an effort to decrease risk is small, and

2.  Overall market risk will not be eliminated merely by adding more stocks to your portfolio.

This is basically what I was trying to say that one reaches a point of diminishing returns when trying to make their portfolio "safer" by purchasing positions in a huge number of stocks.

Of course, there is many different ways to invest successfully.  As someone recently pointed out to me, Peter Lynch, whose book One Up on Wall Street was excellent as well, ran a huge portfolio with hundreds of positions at Fidelity and it obviously worked for him.  I can certainly see the merit of having a huge number of horses in the race in a buy and hold portfolio.  Doing so dramatically increases one's chances of finding the celebrated multi-bagger.  I know that Tom and David Gardner have had much success with this technique over at Stock Advisor.

I'm more of a "rent" a stock than "own" a stock sort of guy.  As someone who doesn't trust himself to time the overall market very well, I would rather buy stocks when they are really cheap and sell them when I deem them to be expensive.  Furthermore, ideally these stocks will have some sort of catalyst that will unlock value at some point in the future after which I can sell them to lock in my gains.  Too many times I have seen the stock of companies soar to the moon only to come crashing down and eliminate any of the "gains" that investors saw by holding them for a number of years.  I look for stocks with attractive catalysts, wait for them to happen (or not...yep sometimes one misses :)) and then sell to lock in my gains.

I do have exceptions to this rule in my portfolio.  I own a few dividend-paying companies that really don't have any specific catalysts, such as EPD, to use them as a source of income that I do not reinvest but instead use it as fuel for new investments.  One almost has to have a few of these sitting around in an era like today where the interest rates on bonds are absolutely terrible.

Investors should always ask themselves periodically why they own a particular equity.  If you can't think of the answer, or if there was a reason that never materialized and you're just holdnig into it for the heck of it, chances are you probably should sell.  Here's a few of the non-SPOPS stocks that I own and why I own them:

VOD: Potential catalysts include the sale of minority stakes in a number of businesses.  The introduction of the iPhone to Verizon Wireless.  Verizon Wireless being forced to pay VOD a dividend causing its already substantial dividend to rise by as much as 50%.  Good exposure to emerging markets.  Increasing proliferation of smart phones causing current subscribers to spend more.

CVS:  The likely influx of new customers created by the expansion of healthcare that the government recently passed.  Increased profitability as a result of the coming wave of generic drug introductions, which are more profitable for pharmacies and PBMs than branded medications.  A demographic tailwind from aging customers who will need more medicine.  Any improvement at all in the company's thus far poorly run PBM business, Caremark.

CAH:  Reasonably valued at time of purchase.  company has raised its dividend every year since for the past thousand years.  Should benefit from several trends in the healthcare sector, including the large number of medications that are scheduled to go generic in the coming years, any expansion of the number of insured by the recent healthcare legislation, and the aging population.

EPD:  Steady growth.  Will benefit from a number of recent acquisitions.  Pays 5.6% dividend, which was higher at the time I initially invested.  Should benefit from any rebound in natural gas demand or prices.

BIP:  A spin-off that pays a tremendous 5.6% dividend.  Took advantage of the credit crisis to substantially add to its portfolio at cheap prices.  Mr. Market doesn't appreciate the company's growth opportunities in Australia.

AWK:  A cheap (at the time), well-run utility that pays a solid 3.2% dividend.  Company signed an agreement not to raise rates for a specific period of time when it went public several years ago.  That period is now ending, enabling AWK's returns to catch up to those of its competitors as it wins rate cases.  Will benefit if cash-strapped governments decide to sell off their water assets.  The latter hasn't materialized yet, but I'm still up over 30% not including divvies as a result of the rates going up.

EXC:  A cheap company that pays an outstanding 5.1% dividend.  Unfairly sold of slightly as a result of unfortunate Japanese nuclear disaster.  Will benefit from any push for "clean" energy, i.e. cap and trade, new EPA emissions regulations, etc...

GOV:  A spin-off that pays a tremendous 6.3% dividend.  Much like AWK, will benefit if the government decides to sell of buildings to pay down debt or reduce deficit.

PFE:  A cheap behemoth that pays a 4.0% dividend.  Has the potential to sell or spin-off a number of divisions to create value.  Will benefit from people being forced by the government to have healthcare.

PWE:  Pays a 4.0% dividend.  Provides my portfolio with much needed exposure to oil.  Serves as an inflation hedge.  Oil in a country that is not only close to the U.S. but an ally at a time when there is constant turmoil in the Middle East.  Brought in billions of dollars by establishing joint ventures with assets that I was assigning little value to...oil sands and shale gas.  Growing reserves by using horizontal drilling.  Has significant tax credits.

SEMG:  SemGroup (SEMG) is a post-bankruptcy pipeline company that is a David Einhorn play. It may change into a dividend-paying MLP in the future.

Whew, this post ended up being a lot longer than I had originally intended.  I guess that you can see I love this stuff.  Gotta Go.  Thanks for reading and please share your thoughts on these special situations or any others that are attractive right now that you are aware of.


6 Comments – Post Your Own

#1) On April 04, 2011 at 5:31 PM, SilverDoctors (< 20) wrote:

I wouldn't forget about a silver commodity play or owning physical silver itself. Our own government is scrambling to find enough silver to fulfill silver contracts according to the AP article from today.

Blythe must be getting desperate- today she called for some assistance from her pals to come up with some physical silver.  AP reports the feds today attempted to confiscate $7Million (181,000) silver Liberty Dollars minted by Bernard von NotHaus. Read the rest here

 I recommend ticker, AG, on a pullback.  It was up close to 9% today.  Highly leveraged company with no debt. 


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#2) On April 04, 2011 at 8:28 PM, MegaEurope (< 20) wrote:

2 ideas that are vaguely special: GM and GLW.

GM is underowned because of bankruptcy, and there appears to be a high likelihood of improved earnings over the next year.

When GLW resolves the lawsuits that have dragged on for the last two decades (asbestos and breast implants) they should see a significant revaluation.  They are in the final stages of settlements (which have already been budgeted for).

I should have bought VOD when you first suggested it.  Oh well, at least I green thumbed it.

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#3) On April 04, 2011 at 10:55 PM, soycapital (< 20) wrote:

"Thanks for reading and please share your thoughts on these special situations or any others that are attractive right now that you are aware of."

I'm not seeing much that appeals to me at these levels. Of the stocks you have listed here which ones seem a good value to you at this time? I'm with BIP, EPD,EXC on your list. BIP has done extremely well, wish I'd bought BAM as well. Four times recently when my CAPS chart looks like it does today we have had a pullback. Shopping for a watchlist.

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#4) On April 05, 2011 at 12:38 PM, CaffeineHead (56.22) wrote:

"Peter Lynch, whose book One Up on Wall Street was excellent as well, ran a huge portfolio with hundreds of positions at Fidelity and it obviously worked for him."

 Although he held hundreds of positions, I believe he mentioned in the same book that the bulk of his portfolio was placed in just a few. He took small positions here and there if he thought there was a possibility of a "multi-bagger."

 He also cleverly points out that in the market you only have to win 6 times out of 10. Also, you can only lose your initial investment, but your gains can be limitless.

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#5) On April 05, 2011 at 6:20 PM, awallejr (37.26) wrote:

I like your BIP pick.  I am eyeing it for personal ownership on any pullback.  You got my curiosity up with SEGM, since healthy pipeline mlps can be great cash generators.  But this one is not acting very well especially for a company that came out of bankruptcy.  It lost over 6% today.

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#6) On April 06, 2011 at 9:33 PM, walt373 (99.87) wrote:

I like BAM and BIP, however, I am bearish on China and I think they will suffer if China does see a prolonged downturn since they have exposure to commodities and commodity-related sectors. I'd definitely be a buyer if they see a big correction.

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