The move off the March 2020 bottom has been an unbelievable vertical assent. Aside from the rally way back in August-December of 1998 (roughly a 30% gain), I can’t remember such a rocket shot of a market. I’m quite sure many of us are enjoying the ride.
There are plenty of you who have probably done very well for yourselves the past year, and you might even have a couple of stocks that have become a huge percentage of your total portfolio. I commend you for your stock picking, but you should also take heed to the hazards of concentrated positions. Mind you, I’m not discussing incentive stock options or RSUs granted by an employer; that’s an entirely different discussion. I’m talking about stocks that you have chosen in your portfolio that have done so well that they’ve become a very large percentage of your overall portfolio.
Most in our business say 5% in any one stock is pretty high, some might say you’re OK until 7-8%, but when you get a stock that’s creeping up on 20% of your total portfolio, this really is the danger zone. Crazy things can happen in the investing world, and even crazier things can happen to any particular stock at any given time. A few of the most common:
Any of these events could send a stock plummeting; 30,40,50% in only a few trading days. The most recent example is the stock of Viacom (VIAC). On Monday, March 22, it was trading around $100 per share, and by the market close on Friday, March 26th…..$48! I would encourage you to read about what happened. The risk to you is that the one beautiful stock, that you love so dearly and has performed so well, becomes your worst nightmare literally overnight. You can’t fall in love with your stocks, because they have no love for you!
To put this into a real example, let’s examine the damage this can do to one’s portfolio. I’m using hypothetical values and rates of return on a total portfolio of $1Mil; $800,000 of which is in a diversified portfolio, and $200,000 is in a single stock XYZ. Let’s say news breaks about egregious improprieties by the management of your favorite stock, XZY, and it’s value decreases by 50%:
| Current Value | Market Growth(for the year) | Future Value(end of year) |
| Diversified Portfolio: $800,000 | 10% | $880,000 |
| Position in XYZ (20%): $200,000 | -50% |
$100,000 |
| Your Total Portfolio: $1,000,000 |
$980,000 |
That 20% position in XYZ just got cut in half due to some random event. At the same time, in the example, the diversified portion of your portfolio made a nice 10% return that year (in line with the market growth). However, your total return for the year was now -2% in what was a pretty decent year for the market, +10%.
If you had the full $1Million invested in the diversified portfolio, you would have ended the period with $1,100,000 vs. the $980,000. That’s a swing of $120,000 just by owning too much of a single stock! To most folks, that’s a material amount of money!
Perhaps you’re thinking “yeah, but this will never happen to me” or “how often does a stock get cut in half?” More often than you might remember, and when you get into a bear market, it happens to many stocks without even needing some scandal to magnify the loss. Maybe you have good fortune and luck might be on your side, but investing is about assessing probabilities, never certainties.
Here at Hodges, we manage portfolios of individual stocks, so we’re well versed in how to allocate percentages to different stocks. If you have a situation like this in your portfolio, and would like help strategizing, we’d like to talk with you.
Avoiding big mistakes is key to generating long term wealth. -Don Phillips (Morningstar)
Hodges Capital Management, Inc. is a Federally Registered Investment Advisory Firm registered with the SEC. The above discussion is not intended to be a forecast of future events, a guarantee of future results, and should not be considered a recommendation to buy or sell any security. Past performance is not indicative of future results. Investing involves risk. Principal loss is possible. Investing in smaller companies involves additional risks such as limited liquidity and greater volatility. No current or prospective client should assume that information referenced in this communication is a recommendation to buy or sell any security. Different types of investments involve varying degrees of risk. No client or prospective client should assume that any information provided is a substitute for personalized individual advice from the adviser or any other investment professional. This document was created for informational purposes only and the opinions expressed are solely those of Hodges Capital Management, Inc.
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