Why I Buy What I Buy

"Tonight
We are young
So let's set the world on fire
We can burn brighter
Than the sun"

-- “We Are Young,” fun., from the 2011 album Some Nights

Let my tribute to National Poetry Month serve as fair warning: If you're very close to retirement and more interested in preserving your capital than growing your nest egg, this article isn't for you. If you're still here, you must be into growth stocks and market-beating returns. I'm here to explain why I invest the way I do with an outsized focus on one market sector, and why it helps me to have decades to go until I collect that gold watch to live off my IRA proceeds.

In short, I think diversification is overrated -- at least in my situation.

Begone, heretic!
Let me be clear: Holding a very diverse portfolio across market sectors, cap sizes, and geographies isn't a bad idea. In fact, it’s a great idea for the average investor. That strategy certainly worked wonders for Peter Lynch, for example. But it's not right for me, and here’s why I think so.

We mortals are often better off sticking with what we know. That's still a beautifully Lynchian thing to do. Yes, you get to pick and choose which parts of a master-class investment style you should follow and which you should discard. Every investor is different.

"Diworsification" at its finest
I tried my hand at traditional diversification once. In the early 2000s, I set up about half of my retirement account to provide exposure to a few important sectors. For the next few years, I held an American carmaker, one of the two ever-dueling soft-drink giants, and a giant money-center bank. My portfolio even backed into a media empire when one of my fast-growing little upstarts was bought out in a cash-and-stock deal.

That portfolio structure didn't last long.

One by one, I cashed out my diversification plays to invest in stocks I truly understood. I sold Bank of America (NYSE: BAC  ) in the spring of 2008, only months before the entire banking sector imploded in the mortgage-speculation financial crisis. But don't call me a genius -- I simply dodged a bullet with my name on it.

Like the carmaker and the soda giant, I sold Bank of America when I realized that I had no business owning it. What set this bank apart from its many rivals? The stock was chosen over its many rivals based on metrics I didn't fully understand. Might as well just throw darts at a list of banking stocks.

I was gambling at best. That's not investing.

It's a marathon, not a sprint
Longtime readers might already know that the capital I rescued from banks and automakers ended up in the tech sector.

Gadgets, telecoms, and entertainment stocks make up my daily beat here at the Fool. In a former life, I was a Unix admin (read: major geek) for two large enterprises. Even my hobbies reek of solder paste and pepperoni.

So why wouldn't I invest in high-tech stocks, where I can tell the winners apart from the losers at twenty paces? My background puts me in a position to understand technology businesses in a way I could never do with investment banking or oil drillers.

You can look at my personal holdings right here, and you'll find one vaguely financial stock amid all the high-tech fireworks. Let me explain that one before you call me a hypocrite.

Retail Opportunity Investments (Nasdaq: ROIC  ) is a REIT, which makes it a second cousin to bank stocks. But unlike the tons of metrics and tortuous market constructs that fuel your average bank, Retail Opportunity is a very simple operation. Buy distressed retail properties surrounded by a very specific set of high-quality demographics, renovate, and lease out the refreshed spaces at a premium. It's so simple, even a caveman (or a geek) can buy it. And if I have any questions, this stock is an official recommendation of four Foolish newsletters, so I have oodles of top-notch research at my fingertips.

But that's a rare exception to my nearly exclusive tech focus. The secret to my investing success is equal parts patience and sector expertise. In 2010, Netflix (Nasdaq: NFLX  ) singlehandedly powered my portfolio to market-stomping returns. Intuitive Surgical (Nasdaq: ISRG  ) picked up the baton in 2011 even as Netflix cratered and I made an unwise bet on OmniVision Technologies (Nasdaq: OVTI  ) . Intuitive remains the largest holding in my portfolio, because I believe robotic surgery will change the face of health care over the next few decades. In OmniVision's case, I'll admit that I overestimated my own understanding of the market for camera-sensor chips. You live, you learn.

The big takeaway here is that one hero stock often makes up for lots of underperformers. Moreover, the losers can redeem themselves in the long run.

Patience, young grasshopper
If you're young, you can roll with the punches. That's a crucial ingredient in my strategy. If I didn't have decades of portfolio repair opportunity ahead of me, I could never take some of these risks.

Netflix remains a leader in the exploding digital media market, and OmniVision's iPhone 4S hiccup was never a structural flaw. Not only did both stocks stay in my portfolio, but I bought more Netflix on the Qwikster dip and repaired my OmniVision holdings by writing a few option contracts. With the cost basis for these stocks dramatically lowered, I'm in the black on Netflix with an eye to stomping the market in the long term and have locked in a roughly 34% gain on OmniVision. Not too bad, I'd say.

The Netflix story in particular may take years to play out in my favor as the company battles skeptics and intense competition at every turn. That's fine by me, because I don't need Netflix to pay off in the next year -- or five. With a shorter investment horizon, my take might be different.

Selling these stocks when the market panicked over their respective troubles would have cemented large losses for me. But I didn't, because it was obvious that the companies would recover. By stark contrast, I'd be sitting on a 75% loss in Bank of America if I had stuck to my guns without understanding why.

Again, I realize that I'm not preaching the traditional Foolish gospel here. Diverse holdings really do anchor your portfolio against market storms in a way that my personal strategy cannot match. Another dot-com blowup could do terrible things to my IRA, for example. But then I'd still have decades of time on my hands to repair the damage, and my good years should easily make me forget the bad ones. This won't work for everyone, but it looks like the perfect strategy in my situation. Maybe in yours, too.

Stick with what you know, love, and truly understand, and you're not likely to make any major mistakes. I don't care whether you're an expert in semiconductors or mortgage lending or high-concept fashion retailing. Either way, you will be able to separate the wheat from the chaff in your industry of choice and make a killing in the process. When you can tell a speed bump from a spike strip, your chances of outrunning the market increase many times over. The smartest investors buy stocks right when they seem doomed to die, then ride them to supersized returns. You wouldn't believe what those geniuses are buying today while everyone else is selling.

Fool contributor Anders Bylund owns shares in Netflix, OmniVision, Intuitive Surgical, and Retail Opportunity Investments, and has written a covered strangle on OmniVision. He holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Retail Opportunity Investments. Motley Fool newsletter services have recommended buying shares of Intuitive Surgical, Retail Opportunity Investments, and Netflix. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On April 06, 2012, at 10:55 AM, johnignite wrote:

    Anders:

    An alternative approach to diversification, which is quite different from conventional investment wisdom, is explained in Mike Dever's book, "Jackass Investing: Don't do it. Profit from it.", (which is the Amazon Kindle #1 best-seller in the mutual fund category).

    One concept that is very interesting in "Jackass Investing" is that the author replaces asset classes with "return drivers" and "trading strategies". As explained in the book, asset classes are simply long-only trading strategies that do not attempt to isolate their many separate return drivers. To be properly diversified, a portfolio must distribute risk across numerous "return drivers".

    When people limit their investment options to traditional asset classes (such as stocks), they are unable to create a truly diversified portfolio. By diversifying outside the constraint of asset classes, they are able to achieve a "Free Lunch," which is a portfolio that earns greater returns with less risk than a conventionally-diversified portfolio.

    Once viewed in this fashion it is easy to create a truly diversified portfolio, rather than one constrained by the shackles of asset classes. Diversification is the one true "Free Lunch" of investing, but it must be true portfolio diversification, as described in "Jackass Investing". It's amazing how logical this approach is yet so few people actually embrace it.

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