Safety in the Market?

In a recent magazine publication an article caught by eye. They had put together a list of “10 Must-Have Shares in a Tricky Market”. The list includes picks that “provide a mix of balance sheet strength, exposure to upside growth potential and an ability to weather any further erosion in economic conditions”.
The chosen stocks were all well-known, highly reputable, blue-chip companies. All the supporting evidence allowed me to conclude that “yes indeed” the people writing the article were extremely accurate and intelligent. It all made sense.
But unfortunately, this is where the Stock Market is poorly understood. The Stock Market is an amazingly efficient mechanism whereby all the available information on anyone company can quickly be priced into a company’s stock. Therefore, shouldn’t all the good news and qualities of the company’s “picked” by the article be already factored into the share price? The market already knows that these are solid companies with good prospects. But does that make them good investments? It’s a different thing.
A good company often is priced at a premium to the market.
And besides, as we’ve seen over the past couple of years, there’s no guarantee anyway that idiosyncratic risk will not mess up your “safe” blue chip gamble (Babcock and Brown for instance).
This is why a concentrated portfolio of blue-chip stocks provides no guarantees. You are simply taking non-systematic risks that you are not rewarded for.
The answer is to diversify, accept that good prospects are almost always in the price already and to understand that low prices relative to fundamental factors mean higher expected returns. The mix of “good” and “bad” companies in your portfolio will depend on your appetite for risk.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances. Comment on this article at http://thenakedinvestor.blogspot.com