Gambling metaphors for investing are a dime a dozen, and they can be misleading, because gambling is often a binary outcome -- you either win or you lose. But let's use one anyway.
If, like me, you enjoy the occasional game of blackjack, you might have heard -- or uttered yourself -- this common lament: "I always hit blackjack when I'm betting the minimum!" A card counter would tell you this happens because you're betting small at the very times that you have the best odds of beating the dealer -- and should be betting big.
Same with investing
Just the same, have you ever had a tiny grubstake on a stock that has absolutely gone crazy? In 1998, in the midst of the Asian currency crisis, I was living in Jakarta and bought a teeny-tiny stake in Telekom Indonesia (TLK) after it had fallen from $30 to below $3 per share. While my investment increased more than eightfold, it meant bupkis for my real-money portfolio. My stake was simply too small to matter.
In our Motley Fool Hidden Gems small-cap service, we recommend that members diversify broadly among 20 or more stocks. This is because small caps can be volatile and diversification can save you from becoming insolvent.
At the same time, however, we see the power of going double-, triple-, or even quadruple-down on certain companies when we have the highest confidence in their prospects and their prices. Let's take a look at what I mean with the following actual five-year returns from some popular companies.
Here's how straight-up $5,000 bets on each company would have fared:
|
Company |
Five-Year Return |
Amount Invested |
Total |
|---|---|---|---|
|
Praxair (NYSE:PX) |
153% |
$5,000 |
$12,635 |
|
Torchmark (NYSE:TMK) |
59% |
$5,000 |
$7,953 |
|
Firstenergy Corp. (NYSE:FE) |
110% |
$5,000 |
$10,502 |
|
General Mills (NYSE:GIS) |
35% |
$5,000 |
$6,739 |
|
Energy Transfer Partners (NYSE:ETP) |
410% |
$5,000 |
$25,504 |
|
AES Corp. (NYSE:AES) |
-30% |
$5,000 |
$3,518 |
|
Exelon (NYSE:EXC) |
160% |
$5,000 |
$12,991 |
|
Total |
128% |
$35,000 |
$79,843 |
Now, let's suppose our investor, with the same $35,000, had put more money on the stocks he thought had more upside potential:
|
Company |
5-Year Return |
Amount Invested |
Total |
|---|---|---|---|
|
Praxair |
153% |
$6,000 |
$15,162 |
|
Torchmark |
59% |
$2,000 |
$3,181 |
|
Firstenergy Corp. |
110% |
$6,000 |
$12,602 |
|
General Mills |
35% |
$2,000 |
$2,696 |
|
Energy Transfer Partners |
410% |
$7,000 |
$35,706 |
|
AES Corp. |
-30% |
$6,000 |
$4,222 |
|
Exelon |
160% |
$6,000 |
$15,590 |
|
Total |
155% |
$35,000 |
$89,159 |
Even though one of this investor's biggest bets turned out utterly wrong (AES, down 30%), he still did much better -- to the tune of 27 percentage points -- than if he'd made even $5,000 purchases.
Make your money count
This should clearly illustrate how powerful proper money management is in juicing your returns -- provided you can identify the stocks with the best long-term prospects. In order to help our Hidden Gems members identify the most promising of our small-cap recommendations, each month Tom Gardner and I publish our top five best stocks for new money in addition to our two new recommendations.
Our goal in doing so is to help our members do even better than the returns on our scorecard -- which have been gratifying thus far, as we've topped the market 27% to 12% since the service began three years ago. If you're interested in seeing our most recent list of top stocks for new money now, simply try a no-strings-attached free trial. There's no obligation to subscribe.
This article was originally published on August 4, 2006. It has been updated.
Bill Mann owns no companies mentioned in this article . The Fool's disclosure policy is -- in the immortal words of Robert Palmer -- simply irresistible.
