As a recreational poker player, I find it exciting to occasionally throw all of my chips on the table and go “all-in.” Sometimes this can pay off, especially during the rare occasion of having pocket aces.
However, this is a concept that I do not recommend with investing, regardless of how much you believe in a company. A disciplined, long-term approach is vital in developing a diverse, well-managed portfolio that will handily beat the market.
I believe that it’s important for each investor to limit their investment in any particular company to a specified level and to make it a personal rule to not exceed this level. My personal rule is 5%, but this will vary from investor to investor depending on their investing experience, investing style, risk tolerance, and current allocation situation.
Great temptations
It is very tempting to break this rule with some companies such as Apple Inc. (NASDAQ:AAPL). Apple Inc. (NASDAQ:AAPL) is a perfect example of how capping the percentage of any one holding could save investors a large amount of heartache.
In a relatively short time, Apple Inc. (NASDAQ:AAPL) has fallen 40% to around $430 per share from its all time high of $700 reached during the fall of 2012. When Apple Inc. (NASDAQ:AAPL) was at $700, everyone loved the company and some analysts had targets of more than $1,000 per share. If an investor would have gone “all-in” at that point by risking a majority or all of their portfolio to buy Apple Inc. (NASDAQ:AAPL) at $700, their stress level and amount of sleep would more than likely have been affected in a very bad way.
Apple Inc. (NASDAQ:AAPL) has a current P/E of 10 and after the recent 15% dividend increase, yields nearly 3%. With a payout ratio of 30%, these dividend increases should continue well into the future.
If an investor would have gone “all-in” two years ago when Netflix, Inc. (NASDAQ:NFLX) was trading near $300 per share, they would have experienced a gut-wrenching downturn to the $50’s. However, if an investor would have gone “all-in” when the stock was in the $50’s during the spring of 2012, they would be more than likely celebrating immensely at a remote beach sipping on an adult beverage of their choice. However, It’s important to note that this would have been a major gamble.
Netflix, Inc. (NASDAQ:NFLX)’s 2012 earnings were down significantly from 2011 earnings due to inappropriately-timed price increases in addition to streaming launches in international markets. The investments to expand its international streaming capabilities should pay off big time in future years. Netflix, Inc. (NASDAQ:NFLX) currently has an impressive 36 million (and growing) streaming customers.
There must be a better way
Instead of going “all-in,” a better method of investing is to build a position over time by buying a relatively small amount initially and adding to this position as attractive opportunities develop. This will ensure that an investor does not buy a full position at or near the top, which would have been the case by buying Apple at $700 or Netflix, Inc. (NASDAQ:NFLX) at $300.
Do not focus too much on price initially. If there is a company with great long-term potential that you would like to own, but the price is slightly higher than you would like to pay, get some skin in the game by opening a small position. By getting a little skin in the game, an investor will be enticed to spend time researching the company, which will lead to an increased level of knowledge, a better feel for when to add to the position, and when it may be time to consider selling.
While buying at a good price is important, focusing too much on the price can cause an investor to miss some great opportunities. I learned this lesson the hard way. Last year I was fired up about buying The Walt Disney Company (NYSE:DIS), which is the most diverse entertainment company on the planet. At the time The Walt Disney Company (NYSE:DIS) was trading at about $42/share, but I decided to hold off until the price dropped below $40.
Guess what? The price never dropped below $40 and kept going up to the recent level of $63. If I would have opened a position by buying a small amount of The Walt Disney Company (NYSE:DIS) at $42, I would be a happy The Walt Disney Company (NYSE:DIS) shareholder now. Also, there would have been multiple opportunities to continue building my The Walt Disney Company (NYSE:DIS) position as a result of temporary price dips.
The Foolish bottom line
Apple and Netflix will more than likely continue to be very volatile. Over the short term, the direction of their stock prices is impossible to predict. However, I believe that both Apple and Netflix, Inc. (NASDAQ:NFLX) will go much higher over the long term.
I recommend that you consider building positions over time in Apple, The Walt Disney Company (NYSE:DIS), and Netflix, that you develop your own personal rule to cap the amount invested in any one company, and that you limit your “all-in” activity to the poker tables!
The article Should You Go “All-in” With These Great Companies? originally appeared on Fool.com is written by Greg Williamson.
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