I'd never recommend that individual investors invest in just six stocks -- the resulting volatility and risk of permanent losses is higher than most people can tolerate. However, with six stocks you can cover the major equity investing styles.
That's a first step toward building a well-diversified portfolio; in addition, combining bottoms-up stock picking with some basic asset allocation considerations is likely to produce better results than stock picking alone. Below, I present six stocks handpicked across six of the major styles and the opportunity to obtain five actionable stock ideas that could be the basis for a market-beating portfolio.
|High growth||Companies with huge growth potential.||
|Small-cap||Smaller, high-quality companies with a long growth trajectory ahead of them. Market capitalization is below $2 billion.||
|International||Companies located outside the U.S. or that derive a majority of their revenue outside the U.S.||
|"Ben Graham" value||Consistent with Ben Graham's investing approach, these are businesses of mediocre quality that trade at a deep discount to their intrinsic value or net assets.||
|"Buffett" value||GARP: growth at a reasonable price.||
|Income||Shares that pay a sustainable dividend, with a yield that exceeds that of the market average.||
I'll grant you those categories sometimes overlap; some stocks don't fit neatly into a box. We can argue about specific cases or even how to define categories, but the important thing to recognize is that the market is made up of different groups of stocks which share certain characteristics.
Let me summarize the investment case for each stock in the table:
High growth: Exelixis
Exelixis has a deep drug pipeline, including cabozantinib, a cancer drug that is moving into Phase III trials for prostate cancer later this year. Investing in biotechnology is inherently speculative, but there is a major difference between an informed speculation with a positive expected value and playing roulette; Exelixis is the former.
Small-cap: Bridgepoint Education
Bridgepoint Education was the classic small-cap growth stock, and while growth is slowing, it remains a cash machine that delivers outstanding returns on equity. Small-cap stocks are expensive right now, so valuation is a key concern in this segment. Bridgepoint is under the pall affecting the entire for-profit education industry due to unfavorable changes in legislation. With shares trading at eight times forward earnings, they offer a comfortable margin of safety to investors who are willing to stray from the herd.
International: Yongye International
The Chinese government, which directs a hybrid command/market economy, recently made increasing domestic food production a national priority. That's no easy objective in a country with one of the smallest proportions of arable land. Yongye International, which sells branded fertilizer, is ideally positioned to take advantage of that effort. Tainted by the spate of scandals at small-cap Chinese companies, Yongye's shares trade at less than 4.5 times forward earnings.
"Ben Graham" value: Aeropostale
It's extremely difficult for companies to create a sustainable competitive advantage in retail, so when you go shopping in this sector, you ought to look for deeply discounted merchandise. In August, the market put Aeropostale in the bargain bin when the retailer warned that second quarter same-store sales would decline once again. Tom Jacobs, the Fool's resident deep value expert, estimates Aeropostale shares are worth somewhere between $20 and $30. True, that's a very wide range, but with shares now priced at roughly $13, it doesn't really matter where in the range the intrinsic value falls (assuming Tom is correct, of course).
"Buffett" value: Berkshire Hathaway
Given Berkshire's size, don't expect moon-shot-type returns. What you can expect are market-beating returns at below-market risk. That's a combination every investor should be able to appreciate -- particularly in this volatile market. I could go on and on vaunting the merits of investing in Berkshire, but I'll simply say that Buffett himself has signaled to investors that paying a 10% premium to book value represents a significant discount to the value of Berkshire's businesses. The shares are trading at 1.15 times book value.
Incidentally, this segment has an incredible density of attractive opportunities right now. I'll just mention three more: Alcoa
Coca-Cola is dividend royalty -- literally, since it is included in the highly selective Dividend Aristocrats index. One of the index's requirements that disqualifies virtually every stock: 25 years of uninterrupted dividend increases. Coca-Cola shares aren't particularly cheap right now, but neither are they wildly expensive.
The next step
Six stocks for six styles and all of them have their place in the Motley Fool's Million Dollar Portfolio, a real-money portfolio that is carefully constructed from the best picks across our newsletter services. If you'd like to learn about 5 other stocks that Million Dollar Portfolio advisor Ron Gross owns in the portfolio with a "Buy First" rating, enter your email address in the box below and we'll send you our free report, "5 Stocks for the Next Bull Market."