When I'm perusing the menu of my favorite Chinese restaurant, I usually end up back at my regular: General Tso's chicken. It's familiar, it's safe, and I know I'll like it.
But sometimes I'm feeling a little adventurous, and I'll want to dabble: Time for a pupu platter.
Many of us come to a similar crossroads in investing, too. We're told that we should buy shares in companies we're familiar with ... but then again, maybe a portfolio should have a "sampler" effect, with a little bit of everything in a diversified portfolio. A pupu portfolio. Such diversity can protect us from the market's vagaries, after all.
We're proponents of sticking with companies you're familiar with and understand, especially for beginning investors. It's a key lesson from Peter Lynch's classic One Up on Wall Street. But that doesn't mean you can't break out of a self-imposed mold. Make sure that by sticking to what you know, you aren't closing your mind to the benefits of a diverse portfolio.
A diverse grab bag
I admit, I'm a big fan of buying what I know. I own shares of Urban Outfitters(Nasdaq: URBN), which I have followed closely for several years now -- not to mention my expensive addiction to one of its stores, Anthropologie. I once held (and unfortunately, long since sold) shares of Amazon.com (NASDAQ:AMZN), a retailer whose virtual mall I have frequented since its launch.
In the two-plus years I've worked at the Fool, I've written primarily about the things that interest me personally -- trends in hot consumer brands, technology, and media. Netflix (NASDAQ:NFLX) is one of the companies I like to watch. It turned an entire industry on its ear by doing what many people thought impossible: offering DVD rentals over the Internet, to be delivered by old-fashioned U.S. mail.
But many of the best-known, hottest consumer brands carry the highest price tags attached to their stocks -- and a whole lot of buzz-driven volatility. Some of you may remember when Netflix's stock took a hit, based on competition from Blockbuster (NYSE:BBI) and the threat of Amazon.com entering the online DVD rental business. It has since recovered, of course, given Amazon's reticence at entering the U.S. market and Wal-Mart's (NYSE:WMT) decision to drop out of the DVD-rental race. Pure-play bricks-and-mortar rivals like Movie Gallery (NASDAQ:MOVI) can't seem to touch Netflix, either.
So where will we find diversity in our portfolios to offset the inevitable market ups and downs that accompany hot stocks? Simple: Find the business models we already know -- in industries we don't follow.
For example, what do Corporate Executive Board (NASDAQ:EXBD) and Netflix have in common? The quick answer: Not much. Corporate Executive Board is as obscure as Netflix is mainstream. Its focus on corporate information is hardly common knowledge to the average Joe, while Netflix's red mailers are part of the decor in many a household. There's a huge difference between corporate information services and renting Old School to people over the Internet, right? Well, yes and no.
Different strokes; investors stoked
Netflix, which David Gardner has twice recommended for Motley Fool Stock Advisor, delivers a popular service to roughly 4.8 million subscribers, based on its most recent numbers. It's got surprisingly low turnover among those subscribers, and it's surely helped by innovative programs like its Netflix Friends feature, which allows users to share movie recommendations and ratings among a network of friends. Netflix Friends creates a community draw, giving subscribers more reasons to stick around.
Despite competitive forces, last quarter Netflix was profitable, managing a 47% year-over-year increase in sales. Meanwhile, despite its highly competitive category, it sports $228 million in cash and no debt.
Corporate Executive Board doesn't share the pop-culture spotlight that Netflix enjoys. But it does have a few other similarities, most notably its subscription-based model and strong subscriber retention. Although plenty of corporate consulting firms that might spring to mind -- McKinsey & Co., Electronic Data Systems, and IBM, to name just a few -- Corporate Executive Board has few direct competitors because of its innovative positioning. It can offer its services at a fraction of the prices charged by most consulting firms, drawing upon its global community of corporations to help provide solutions to its base. That, in turn, helps to bolster subscriber loyalty.
When Tom Gardner singled out Corporate Executive Board for Motley Fool Stock Advisor in August 2002, he recognized a real strength -- a subscription-based model that fostered loyalty (in 2005, its client renewal rate was 92%). Corporate Executive Board sells collaborative business research to its member companies. At the moment, it boasts 2,800 large corporate members, including more than 80% of the Fortune 500. Each pays a large yearly fee to join the network, where they share ideas, problems, and solutions. Corporate Executive Board, in turn, transforms this community-created data into analytical reports.
That approach has helped the company achieve steady growth and high renewal rates. Meanwhile, as you can imagine, capital expenditures are low. Corporate Executive Board recently reported several exciting quarters, with sales growth rates of roughly 30%. It also has a strong, debt-free balance sheet, with $345 million in cash and short-term investments.
So there you have it: two companies with similar strengths -- although at first glance, you'd never think to compare them.
Buy what you know ... and what you get to know
Netflix and Corporate Executive Board are prime examples of stocks that seem to lack any similarities, but both have made great additions to investors' portfolios. Indeed, Corporate Executive Board shares have increased more than 245% since Tom recommended the company in 2002. Even if you subscribe to the tenet of buying what you know, getting to know more stocks gives you a better shot at a more diverse portfolio.
Not sure how to start? A service like Motley Fool Stock Advisor can help you diversify your investment portfolio by finding opportunities similar to the stocks you already know, in places you might not have previously thought to look. Click here for a 30-day free trial to Stock Advisor, and you'll get immediate access to more than 60 formal recommendations Tom and David have made since the newsletter's inception.
So whether you go for General Tso's chicken or branch out into the pupu platter, buy what you know -- but don't box yourself in.
This article was originally published on Jan. 18, 2006. It has been updated.
Alyce Lomax owns shares of Urban Outfitters but none of the other companies mentioned. Her Netflix queue has a whopping 295 movies in it, so she's not going anywhere. Amazon.com is a Motley Fool Stock Advisor pick. Wal-Mart is an Inside Value pick. The Fool has a disclosure policy.
