The odds were stacked against David as he stood in front of Goliath. After all, he was just a young shepherd, and his opponent was a skilled warrior who singlehandedly intimidated and frightened the rest of David's camp. Just how did David expect to topple the giant?
Now, David believed he had God on his side, but just to be sure, before the battle he went down to the riverbed and collected five stones for his sling. These weren't just any stones, though. He selected five ideal smooth stones, so that even if the first shot missed Goliath's massive melon, he could be confident in his subsequent throws.
Slay your Goliath
The point of this biblical metaphor is that David recognized the enormous risk he faced (one miss and he was toast!) and didn't bet his life on just one stone. Instead, he picked five ideal stones that -- taken together -- gave him the best chance of success.
Growth investors often find themselves in a similar situation (save the Philistines) when it comes to picking high-risk, high-growth stocks. One particular stock might look like "the one": a quick multibagger with providential traits.
The temptation to go all-in on a stock like this is strong.
Be sure to hedge your bets
But, like David, growth investors would still be wise to spread their bets, just to be sure. Yes, if that one stock turns out to be a real winner, you might miss out on absolute gains, but by using broader diversification, you'll avoid destroying all of your savings in case the unpredictable happens.
For example, let's say you were confident in the prospects of the health-care technology industry in April 2005 and specifically in biotech CV Therapeutics
But if you invested $5,000 solely in CV Therapeutics in April 2005, you would be out $2,600 today, because Ranexa has thus far failed to live up to expectations.
If you had instead spread that same $5,000 among a small collection of promising health-care stocks, the results could have been a lot better. Consider:
|
Company |
Amount Invested on April 15, 2005 |
Return |
Value Today |
|---|---|---|---|
|
Affymetrix |
$1,000 |
(46%) |
$540 |
|
CV Therapeutics |
$1,000 |
(52%) |
$480 |
|
Human Genome Sciences |
$1,000 |
2% |
$1,020 |
|
ImClone |
$1,000 |
43% |
$1,430 |
|
Intuitive Surgical |
$1,000 |
600% |
$7,000 |
|
Total |
$5,000 |
109% |
$10,470 |
As you can see, just one big winner in a high-growth portfolio can make up for a few big losses and simultaneously reduce your risk. But as Peter Lynch has noted, it's very hard to pick the one clear winner from a small group of promising stocks. So while you would have done best putting all of your money in Intuitive Surgical, you would have mitigated your risk and earned good rewards spreading your money equally across these names.
Victory is yours
If you went all-in on one of this year's big winners like First Solar
When it comes to investing in risky but promising stocks, even "sure bets" can miss their mark. An FDA trial could get complicated, a new technology could fail to take off, or competitors could enter the market and disrupt margins. Stuff happens. That's why it's important to shoot for market-beating performance with more than one promising stock.
If you're looking for some promising growth stocks for your portfolio, Motley Fool co-founder David Gardner and his Rule Breakers team can help. For the past three years, the Rule Breakers team has recommended high-growth stocks from a variety of industries. Some have hit rough patches (like CV Therapeutics), while others have thrived (like Intuitive Surgical), but altogether the picks are outperforming the market by 24 percentage points on average.
Interested? Free trials to Rule Breakers are available for 30 days. Just follow this link for more information.
Fool contributor Todd Wenning never knew there would be such a great investing lesson in the Old Testament. Affymetrix is also a Rule Breakers pick. Not now, chief, the Fool's disclosure policy is in the zone.
