Diversification Strategy: Between Blue Chips and Second Liners

A friend of mine once asked, ‘Dear Sir, do you know why Warren Buffett does not like the stocks of technology? I mean, if he acquired Apple, Google, Microsoft, etc., he might earned enormous gain in the long term.’ And I answered, ‘Buffett said that he does not understand technologies. But I think the actual reason is because he realized that this kind of business has high risks. For example, between the year 1995 – 1999, there were many technology companies established in the United States, including internet companies, until occurred an event that known as dot com bubble. But after the bubble was burst, almost all of the companies went bankrupt except Google and Yahoo.’

The problem is, okay, if we bought the shares of Google or Yahoo, then our portfolio would be just fine. But what if we bought any other internet stocks? Then you’d be doomed! While to identify a hidden gem (in this case Google or Yahoo) among a pile of crap, is not an easy job.

But the point is, regardless of the kind of industry that the company run, Buffett prefer a stock or company that has been established and operating for a long time, in this case tens of years, and have experienced any kind of economic downturns and survived. When Berkshire Hathaway acquired a portion of a computer company, the IBM, that’s not because Buffett was suddenly understand about technology, but because IBM is a well established company and has a long history since 1880 (more than 130 years ago), and of course: Has experienced many of crisis periods and survived. Buffett did not bought the Facebook, although it is also a technology company, because FB is a brand-new company that established in 2004.

So the conclusion is, Buffett prefer blue chip companies than smaller companies, or called second liners. And among the largest technology companies in the world, like Lenovo, Hewlett-Packard, Dell, Oracle, or Microsoft, IBM is the oldest and the most well-established.

All this time, there is a myth that a big and mature company is not ideal for long term investment because they did not offer substantial growth, as they were already big. For example, IBM. With assets of more than US$ 126 billion as of the end of 2013, then how could the company grow its assets to be, let say US$ 300 billion, in the years to come?

While for a new company, a start up and small company, then of course its space for growing further is wide open. There lots of examples of small company that could grew several fold in a relatively short term of time, let say less thaun ten years. One of the is Facebook. When Mark Zuckerberg filed the document of establishment of a company named Facebook in July 29, 2004, the value of paid capital was only US$ 55 thousand. And now, what is the current book value of Facebook? About US$ 15.5 billion! So you can imagine, how big the gain of the investors who help the establishment of the company (long before Facebook went IPO in 2012, there were several venture capitalists that inject capital to the company).

So it is clear that if compared to the growth of any blue chip companies in the last ten years, the growth of Facebook is much more impressive. Of course Mark, along with his fellow investors of Facebook, became rich because of their investments.

Buuut.. do not forget that Facebook is a small example, or even maybe the only one, of a small company that could become a giant in an instant.  While the other set-ups? Either internet company or else? Well, some of them were collapsed just after the establishment, some of them survived for a moment but eventually died, som of them survived until today, and some of them are actually grow but with a small rate. While a great success like Facebook, it might be one in a thousand. Peter Thiel, one of the initial investors in Facebook that bought 10% of the company’s shares in 2004, today is a billionaire because of his investment. However, Thiel did not only invest in Facebook, but also in many other start up internet companies, and some of them were actually collapsed.

The conclusion, Thiel’s method of investment is a high risk one, where he could suffer a great loss because the majority of his investment may fail. Nevertheless, if he succeeded in just one or two investments only, then he would be rich.

Okay Sir, so what’s your point?

In an event of investor’s gathering, I met an investor that has been experienced since 1999 (I myself began my investment career in 2009). He told me that, based on his experience, there are lots of investors who ‘do not understand nothing’ but successfully gained substantial profits in the long term because they only invest in an ‘ordinary stocks’, in this case blue chip stocks, usually with the method of Dollar Cost Averaging (DCA). The example of those ordinary stocks are Astra International (ASII), Unilever (UNVR), Indofood (INDF), Bank BCA (BBCA), Bank Mandiri (BMRI), and so on. These ‘know nothing’ investors only picked those stocks because of simple reasons, like, ‘I know Astra, I mean, who don’t? So I feel safe when I bought the shares. But if this company, that company, bla bla bla (small and less popular companies), what is that? I don’t even hear the name!’

While ‘expert’ investors who were excellent in analyzing the prospect of the company etc., instead of making enormous gain, most of them suffer losses! Because they are prefer smaller companies which, as they said, based on their depth analysis, offering significant gain in the long term. But in fact, some of these small companies might have a well financial performance so its shares surged, while in the other time, their performance may suddenly down, so its shares fell.

While for the blue chip companies, whose performance is stable and consistent, the shares has almost no volatility but keep rising over time, although the increase was seem slowly, and only go down if the Jakarta Composite Index (JCI) drops. And this is why the investors that hold ASII et al gained more profits after five or ten years, compared to investors that whether realized or not, risking their money in small and ‘unclear’ companies.

Of course, not all investments in small or second liner stocks would be a failure. In years before 2010, Charoen Pokphand Indonesia (CPIN) was a second liner stock that is also not popular. But after 2010, the company grew significantly and managed to keep their bold pace until today, so the stock rose to become one of the blue chip. If compared with long-term growth of any other blue chip stocks that were blue chip since the beginning, then CPIN scored far more profits. An investor who bought CPIN in the year of 2009 would be more succeeded today in his investment compared to investor that bought ASII in the same year.

So, CPIN is just like Google, Yahoo, or Facebook, which managed to survive and even evolve to be a huge corporation. But the problem is, once again, okay if since the beginning, it was CPIN that we bought. But what if we bought any other second liner stocks? How do we know that if there are two new and small companies, both with no track records of strong financial performance, then one of them would be a giant company in the future while the other will be bankrupt???

Frankly, I was one who believed that second liner stocks offer more gain than blue chip ones. And that’s not because I believe that these second liners has more growth opportunity, but because from the point of view of valuation, these stocks are cheaper than blue chips, with PBV, PER, and dividend yield that are much lower (as a value investor, that’s all I need). While big cap stocks, with popular names and excellent long track records, most of them are premium priced and rarely sold at PBV less than 2 times.

And in the year of 2010 – 2012, the strategy of ‘focus on second liners only’ was successful where there were some good second liners that get into my portfolio, like MNCN, ASRI, GTBO, MYOR, LSIP, KKGI, ERAA, MAIN, to CPIN. But today, the financial performance of some of them are just disappointing and as a result, the stocks back to their nearly initial price. While blue chips? They’re keep going! I just realized that if you bought BBRI in 2010, and still hold it until today, then you’d gained the same profits, or even more, compared to if you buy and sell the above second liners. I mean, if you didn’t immediately sold KKGI in 2012, then you’d be stuck. But if you are ‘sleeping’ while holding BBRI, then your portfolio will be just all right, right?

That’s why, from now on, I personally will take about a half of my assets, or maybe more (but not whole assets), to be allocated into blue chip stocks, although I need to wait because at this moment, the JCI is still a little bit overvalue. And this decision is not solely because I read books about Warren Buffett or the like, but because experience. Of course, you may have a different strategy and that’s fine. But if you are interested to employ the same strategy, then remember that ‘blue chip’ is not just stocks that liquid, but stocks with criteria as mentioned in this article.

Then about blue chip valuations that are (mostly) higher than second liners, then that’s not meant that these blue chips are overvalue. Like Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’. And, well, as an investor, I didn’t understand the words, but now I do.