Every week on Motley Fool Backstage Pass, there's a show called "The Rank" where contributors collectively rank stocks according to their conviction going forward. In this video clip recorded on Nov. 1, contributors Jason Hall and Jon Quast ranked Tanger Factory Outlet (NYSE:SKT) much higher than fellow contributor Danny Vena did, and they want to know why he ranked it so low.
What followed was a conversation about what diversification means when building a stock portfolio. And that's what got Danny talking about why he bought shares of Canadian National Railway (NYSE:CNI) in his otherwise tech-heavy portfolio.
Jon Quast: Danny, you're not convinced. You had this ranked number nine. You're only want to rank it nine here. What's the counter argument here?
Danny Vena: The counter argument for me is, first of all, it's an an area that is out of my field of competence. I'm very comfortable in the technology sector. I'm comfortable in the consumer goods sector. But if you look in my portfolio, there's a few things that you're going to see an absence of. You're going to see an absence of Real Estate Investment Trusts. You're going to see an absence of industrials. You're going to see an absence of all of the stocks that I don't feel comfortable enough that I can make a qualified judgment.
As a result of that, whenever you get a company like that, that I don't really follow that closely, you're going to see it rank -- and I think Matt has talked about this too -- if it's out of your circle of competence, you're not going to feel confident enough to rank it number one, two, or three where you might do that with your own.
Jason Hall: And you shouldn't.
Quast: I love what you are saying there. Because I think that sometimes, one of the things that we do preach is diversification. Absolutely believe in diversification, but I think that sometimes people feel like by a need to diversify their portfolio, that means that they should be investing in all of these industries that they don't even know anything about just because that's diversification. And really what diversification is not putting all your eggs in one basket, in one company, diversifying it across things that you know and understand and believe can create shareholder value over time. For you personally, that's very heavily in the technology sector. If you look at your portfolio, I imagine it's very tech heavy, but it's still diversified across many companies.
Vena: Absolutely. I'll throw you a curve ball here. This might even surprised Jason.
Hall: Oh boy.
Vena: You may not know I actually have a railroad in my portfolio.
Hall: Canadian National?
Vena: It is indeed. The reason that I own Canadian National is because if you go back to 2009, when we were in the great recession in the early part of the year. First of all, you had Warren Buffett was unloading his elephant gun and buying into Burlington Northern Santa Fe, the BNSF Railroad. Soon after that, David Gardner came out and said there's another railroad that is a compelling bargain right now. And he recommended Canadian National. I bought into shares of that back then and have owned it ever since.
Hall: I'm going to throw one thing in here, Jon, before we move on to our next one. I'm going to say right now I'm probably more wrong about that one than I want to admit. But I think the risk with diversification for diversification's sake, into things you don't understand you can't borrow conviction and it can backfire. It can blow up in your face because you can borrow great ideas. But if you don't understand it, you have no reason to have high conviction in it and it's really hard to hold through tough times and even great times, when the stock goes up.