Size Doesn't Equal Safety

There's something I find reassuring about the words "blue chip." It's a feeling akin to being safe at home, or getting a comforting pat on the back from a big brother.

In times of trouble, we all want the comfort of home. Now is no exception. Some days, I think I'd rather be in bed watching reality TV, than in my office watching the bears beat up on the bulls yet again. But staying home won't make the problem go away -- and neither will investing in blue-chip stocks. 

Beware conventional wisdom
We assume that large equities offer safety. Guess again:  

Stock

Price

52-Week High

% Difference
From 52-Week High

Citigroup (NYSE: C  )

$31.40

$57.00

(45%)

Bank of America (NYSE: BAC  )

$43.24

$55.08

(21%)

Pfizer (NYSE: PFE  )

$22.78

$27.88

(18%)

Wendy's (NYSE: WEN  )

$28.83

$42.22

(32%)

Whole Foods (Nasdaq: WFMI  )

$43.44

$53.65

(19%)

Amazon.com (Nasdaq: AMZN  )

$79.11

$101.09

(22%)

American International Group (NYSE: AIG  )

$55.47

$72.97

(24%)

We could have added a few more names to this list, including Yahoo! and JPMorgan Chase.

As much as we might want to, we can't hide under a rock, put our investments in a few big companies, and hope the market's turmoil will leave us unscathed. The big guys bleed, too. What's an investor to do? 

Focus, focus, focus
Most advisors will tell you that a chart like this makes a good argument for diversification, and they're not wrong. While Wendy's, Amazon, and AIG have had a rough year, chances are the other big guys will carry the burden for a while, counterbalancing these stocks' drag on the index. For conservative investors, it's another reason why diversification makes a lot of sense, and why a low-cost index fund might be a great strategy.

But as we've seen in the past, diversification also comes with a downside. You might not do worse than the market, but you won't do much better, either. To beat the market, you need to focus your investments -- and hold far fewer than most managers do.

This strategy will definitely make your portfolio more volatile. Still, if your valuation is sound, it'll also give you the most outsized returns over the long term. That's how Joel Greenblatt, famed author of The Little Book That Beats the Market, achieved 40%+ average returns over the majority of his investing career.

In the short term, anything can happen; some of the greatest investors are having a tough year now. Focus is the name of the game, Fools. Do good research on your companies, value them soundly, and invest in a focused manner with cash you can leave in the market for a few years. The results can be astounding.

Two for the road
Target and Sears Holdings are just a couple of places you might start digging for these opportunities. Both have valuable real estate and credit card portfolios, and both are outstanding companies with strong balance sheets and easy-to-grasp business models. The housing slump might linger a while, and consumers might reduce their spending, but these companies will make it through. Value investing is about buying and selling when everyone else is doing the opposite.

The term "blue chip" has its origin in casinos and poker, where the chips that were blue had the highest value. In one sense, investors aim to own as many blue chips as possible. But the point of investing, like playing poker, isn't to buy into blue. It's to create new value by turning one blue chip into five. Unlike Las Vegas, the odds on Wall Street change daily. Right now, they're in your favor. Step up and place your bets, Fools.

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