Diversification vs Concentration

In my mind I have debated for most of 2012 on whether I should run a concentrated portfolio.  During the year, I have read arguments from both camps.  Off the top of my head, I think of Buffett/Berkshire and Berkowitz/Fairholme as prime examples of strong returns in concentrated portfolios. 

The argument of why you would want to put 2% of your portfolio in your 50th best idea seems very logical.  I agreed with this argument and started moving to a more concentrated portfolio.  However, during the year a few stock selections underperformed (relative to others I also found undervalued) giving me pause.  As my mind wrestled about it more, I realized that being concentrated is trying to predict the timing and catalysts in the future. 

In the past, I have noticed that I am wrong (as most people and commentators on TV) more then I am right in projecting the future.  Yet, I would continue to make projections and say to myself I know the company better I've been following it for 2 years vs 1, or something to that effect.  That being said, my forecasts did not get any better.

One well known study by Dr. Paul Slovic in which horse handicappers did no better (but became much more confident in their predictions) with more data is written about at Motley Fool (I've read at other places but can't remember the original source).   

The best real life example this year was Citigroup (C) vs Bank of America (BAC).  At the start of 2012, I felt that C was better for two reasons.  One, C was more undervalued then BAC and second, that C would come back to fair value faster.  I only bought C and was rewarded with only (I say only but really can't complain) a 40% return.  Had I also owned BAC, I would have received a 100% return.

So where I am going with this post is that if I find 50 stocks that are undervalued, I should own them all as the catalyst/timing for the future is unknown.

Source: Yahoo Finance

Interviews with Sean Egan (of Egan Jones) and Vikrim Pandit

http://www.zerohedge.com/news/egan-jones-europes-eur25tn-hole

JEF looks interesting since it was cut in half from 27 to 12, but in this environment you can't touch it.  Egan makes good points in that there is other risk in their holdings besides PIIGS debt. 

http://globaleconomicanalysis.blogspot.com/2011/11/citigroup-ceo-claims-citi-has-learned.html

What has Citi learned since the 2008 financial crisis?  Leverage and how it leads to most crises over time.  

Long Citi (C)

What We're Reading 10/20/2011

While this article ignores dividends, 'dead money' stocks returns can be improved by selling options. 

Pick your poison, financial stocks are cheap if you have a longer term view.  (link back to article written here discussing tangible book value)

GMCR presentation by David Einhorn (Short GMCR).  My main thesis was that GMCR was not worth half as much as SBUX.  At the time I went short, GMCR market cap was 55% of SBUX.

Pick your poison - Tangible Book Value - major banks have reported

All of the major banking franchises have reported. 

5 of the 6 trade under their Tangible Book Value (TBV), some by a significant margin like BAC at 49%.  While I can understand trading under TBV when TBV is declining.  In every case, TBV is increasing YoY and some significantly.  I believe based on the numbers C is probably the best risk/reward buy right now with the second lowest ratio while having the highest growth rate. 

Long BAC, C, JPM, MS, WFC.  I am looking to sell WFC and potentially buy GS in the next 72 hours.