Lessons from the fall of General Electric
What does that mean anyway, “blue chip” company? The term actually derives from poker. Poker chips are typically red, white, and blue – and the blue chips are worth the most money. But does betting with a blue chip make you more likely to win your hand? Does investing in a “blue chip” company make you any less likely to experience investment loss?
There are few companies whose chip is any bluer than General Electric. This is a classic widows and orphans stock. You buy it, hold it for its dividend, what could go wrong?
Except over the last 12 months, General Electric lost over 56% of its value, and the dividend has been slashed. Decades of mismanagement and strategic blunders have cost the firms investors dearly. Capping a very bad year for GE, on Monday Dow Jones booted the firm from the Dow Jones Industrial Index of which its been a key component for generations.
So what’s my point in bringing this up?
The point is that if GE can be down 56% in a very strong economy, then THERE CLEARLY IS NO SUCH THING as a safe stock. I don’t care what firm it is – having too much of your net worth in one stock exposes you to unnecessary risk. No company is immune to external shocks, all management teams are human. This is why diversification is so important. The best way to avoid these risks is to spread your investment bet across many different companies, in many different industries. And the easiest and most effective way to own a large number of stocks is to invest in mutual funds or ETF’s. For those who prefer to invest in individual stocks, about 20 or 30 stocks spread across different industries should provide adequate diversification for most investors.
As investment advisors we often suggest to clients with large individual stock positions which make up a disproportionate share of their portfolio, that they should consider selling all or some of the position and diversifying their investment. There is often great reluctance to implementing this advice. Some folks don’t want to pay the capital gains tax, others seem to have some emotional attachment to the stock (my father bought it in 1962), others may look at the stock through the prism of excellent past performance which makes the stock seem invincible. All of these are are emotional responses, and none are valid arguments for not diversifying.
The recent experience of GE is but the latest of many former "blue chip" firms who either no longer exist or are a shadow of their former selves. Each failure should serve as a stern reminder that no one’s favorite stock is bulletproof. Each company's demise represents scores of investors who thought their favorite stock was special - only to see their investment slowly (or not so slowly) erode. Concentrating your investment in a single stock is risky. The cure is easy. Sell and diversify.