Pick well and you can make a shedload of money. Pick poorly, however, and you could lose all your capital. Here’s one stock that I think might just do the former.

Soaring small-cap

I’ve owned shares in would-be nickel producer Horizonte Minerals (LSE: HZM) for a few years now. For much of this time, my investment has been under water. Mercifully, that’s now changed.

Horizonte’s share price is up a little over 50% in the last month alone. Had you picked up the shares back in the dark days of March, you’d already be sitting on a gain of around 240%.

Aside from the bounce seen in markets generally, the reason for the price charge is down to Horizonte getting ready to build its Araguaia ferro-nickel mine in Brazil. This is one of two Tier 1 projects that, importantly, are 100% owned by the company.

Show me the money!

Earlier this month, Horizonte announced that it had mandated five international financial institutions to raise up to $325m in debt to part-fund the Araguaia build. Coronavirus-dependent, this should be done by the end of 2020. The remainder of the money needed ($125m) will then come from offtakes and a likely equity raise. 

Should things go swimmingly (and existing holders aren’t massively diluted), I can see the small-cap’s shares being worth multiples of their current value in a few years. This is assuming, of course, that Horizonte isn’t acquired beforehand. With few nickel-focused assets so close to production, it must surely be on the radars of the usual (mining) suspects.

Nickel price play

A takeover becomes even more likely if the price of nickel keeps rising. Thanks to growing demand from the EV battery sector and stainless steel market, there’s certainly a chance it could hit the $16,133/t analyst consensus for when Araguaia is ready to roll.

The ‘Tesla-effect’ can’t be discounted either. Let’s not forget that Elon Musk recently urged miners to dig up as much nickel as they could, adding that Tesla would award a “giant contract for a long period of time” to the company that does so in an efficient and environmentally friendly way. This is where Horizonte’s second Tier 1 asset — Vermelho — comes into play. 

Before you buy this small-cap…

But let’s not get ahead of ourselves. Despite recent progress (and a £15.6m cash position), Horizonte remains a high-risk proposition. Plenty of miners come a cropper on funding and the small-cap could still rip the shirt from your back.

Even if all the funding is secured, there will be traders ready to bank profits. This ‘sell on the news’ strategy means those intending to hold for the long term should brace themselves for volatility.

It also makes it essential for them to be diversified elsewhere (as I am) and not bet the house (which I haven’t). Like all investments, your exposure should take into account your financial goals, age and risk tolerance. If your stake keeps you awake at night, you’re probably doing it wrong. 

All caution (and bias) aside, however, there’s a chance the reward might be worth the wait.

The post Want £10,000? I’d buy £2,000 of this risky UK small-cap stock and wait appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Paul Summers owns shares of Horizonte Minerals. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

It’s still early days, but that call is already looking good with news the company has achieved first oil at its Lancaster field in the Rona Ridge area, west of Shetland. The field — discovered 10 years ago — has been estimated to hold more than 500m barrels of oil. 

This is a huge achievement by Hurricane and its CEO Dr Robert Trice — who first proposed looking for oil in fractured basement reservoirs in the UK — and an egg-on-face moment for those who doubted it would ever happen.

For sceptics, this method was too difficult and costly to be worth the trouble, despite already being employed successfully elsewhere in the world.

According to the company, the combined flow from the wells hit the planned production rate of 20,000 barrels of oil per day during the 72-hour production test and marks the beginning of the development of Hurricane’s “considerable” resources in this area. 

What next?

Having got the Lancaster field into production, Hurricane will now be looking to ramp up its Early Production System (EPS) with the goal of achieving operating efficiency of 85% over the long term.

As previously indicated by the company, it expects efficiency of 45% over the first three months with an average production rate of 9,000 barrels. This will then rise to 65% and 13,000 barrels for the following three months.

It’s hoped the data acquired during the EPS phase will allow Hurricane to “optimise” locations for additional wells in the future.  According to Dr Trice, as much as “12 months of stable production will be required in order to provide a clear view of the reservoir” and allow Hurricane to plan for turning Lancaster into a full field development. 

I don’t hold. Have I missed the boat?

Not necessarily. Given that Hurricane’s shares are up 33% in value in less than a month, there were bound to be a few investors out there wanting to bank some profit and ‘sell on the news’. Indeed, the stock already appears to have lost momentum after initially spiking 7% this morning.

Nevertheless, I’m of the opinion Hurricane’s potential resources make it one for risk-tolerant investors to tuck away for a while. Let’s not forget that Hurricane believes Lancaster and another discovery (Halifax) have the potential to be a single, massive accumulation of oil and that it owns 100% of the licences covering this area. 

The same goes for the Greater Warwick Area — which features the Lincoln field and Warwick prospect — which is currently being developed through a 50/50 joint venture with Spirit Energy. 

Last week, analysts at Berenberg set a target price of 100p on the stock. That’s 66% higher than where it is right now. Naturally, it may be a while before it gets there but today’s update, coupled with the fact Hurricane delivered first oil when it said it would (and within budget) leads me to suspect it could hit this target within the next year. 

The £1.2bn-cap will hold a Capital Markets Day next month where it intends to reveal the results of initial analyses.

The post Today’s news makes me even more bullish on the Hurricane Energy share price appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Paul Summers owns shares in Hurricane Energy. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Compounding

Let’s start with compounding. If I had to list the single most important concept to understand when it comes to wealth generation, this would be it. Put simply, it’s the secret to getting rich.

Compounding refers to the process of earning interest on your interest, or earnings on your earnings. The reason that compounding is so important when it comes to building wealth is that if you can compound your money by continually reinvesting your earnings, your money will grow at an exponential rate.

Just look at the chart below which shows how £10,000 grows when it’s compounded by 10% per year. In the first year, the gain is only £1,000. Yet by year 50, the gain is over £100,000 per year. That’s the power of compounding.

Ultimately, the sooner you begin compounding your money, the more wealth you can generate.

Risk and return

Next, it’s critical to understand that in the financial world return is directly proportional to risk. So, if you want to generate a healthy return on your money, you will have to take a degree of risk. This means investing in higher-risk assets such as stocks.

Many people don’t like taking any risk at all with their money, so they leave it sitting in a Cash ISA earning 1%. That’s fine, but it makes the process of building wealth extremely difficult as inflation actually erodes the value of the money over time.

The bottom line is that unless you’re earning an astronomical salary, investing your money in growth assets, which are higher risk than cash savings, is the best way to generate wealth over the long term.

Capital preservation

Finally, the third vital concept to understand is that of capital preservation. If your goal is to build your wealth significantly, it’s important to have sound risk management processes in place so  you don’t lose too much money on any one investment. As Warren Buffett says in relation to investing: “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1”.

Losing vast amounts of money can really set you back. That’s because when you do, you have to make much more, percentage-wise, just to break even. For example, if you lose 50% on an investment, you have to make a 100% return just to break even. Lose 80% on a stock, and you need a 400% return to make it back to square one.

Perhaps the easiest way to lower your overall portfolio risk and reduce the chances of losing a lot of money is to diversify your capital across many different asset classes, sectors, stocks, and geographic regions. This way, if one asset struggles, it shouldn’t impact your overall returns too badly.

Investing doesn’t need to be complex. But you do need to get the basics right. Focus on the three concepts I’ve discussed above, and it will make the process of building up your wealth far easier.

The post Want to get rich? Here are 3 things you need to understand right now appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

There are a few reasons for this, including their ability to grow profits at a rate that the vast majority of bigger businesses can’t. The fact that a lot of professional investors aren’t permitted to buy such promising firms for their funds also means that these stocks are usually under-researched and often mis-priced.

Before leaping into purchase a stake in a small business, however, I think it’s essential to have answers to the following…

How risky is this investment?

Some small-caps can be high risk with seriously volatile prices. While the latter is perhaps to be expected if they initially struggle to weather changes as well as their larger counterparts, we want to avoid those picks where there’s a real chance of losing all our money.

I freely admit that some of my earliest investing mistakes involved buying (thankfully small) stakes in speculative stocks where success was dependent on a single product, or securing a contract with a particular client. Not smart.

So if you’re are going to go down this route, just make sure your money is diversified into a sufficient number of shares (although keep an eye on fees). Either that, or buy a small-cap fund that instantly spreads your cash around several hundred/thousand companies in one mouse click.  

How many shares do management own?

Find a market minnow that takes your fancy? Go straight to its website and click on the link that provides information on who the major shareholders are. If you can’t see the names of key management, that’s a potential red flag. 

There’ll be exceptions to this of course but, as a rule of thumb, you probably want to avoid companies that aren’t backed by the people running them. If directors don’t have much or any ‘skin in the game’, how incentivised do you think they’ll be to really grow the business?

For this reason, look to buy into firms where managers are also significant part-owners. This should mean their interests are aligned with those of private investors such as yourself. 

On a related note, it’s also worth checking out the track records of a company’s leaders. A chequered history should be another warning sign. 

What are the finances like?

Naturally, small-cap shares don’t have the resources that their bigger, more established peers do. As such, I make a point of trying to avoid companies with stretched balance sheets.  A lot of debt is a big negative, especially during a downturn.

Holding shares in firms that might require cash in the near term is also problematic since a placing will dilute existing shareholders. Moreover, there’s a chance that sufficient cash can’t be raised.

Do you have the patience?

Investing is a long-term game and this is particularly true of small-caps. While the odd oiler, miner or biotech company might strike it lucky once in a while — rewarding its investors quickly in the process — to really reap the small-cap effect, you’re going to need to have the patience to buy and hold during difficult periods. 

And if the Brexit debacle has tested your resolve, there are other options.  

The post Don’t buy a single small-cap stock until you can answer these 4 questions appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

With this in mind, here are three lesser-known stocks that I think can be comfortably bought and held through good and bad times. 

Massive market share

Small-cap kettle safety control designer and manufacturer Strix (LSE: KETL) has already done rather well for early holders since coming to the market a little over one year ago, rising 23% in value. 

While there’s probably no danger of the share price boiling over, last month’s trading update was certainly reassuring. In addition to stating that the company’s performance so far in 2018 had given management confidence that results for the full year would be in line with expectations, the mention of “particularly strong performance in North America” bodes well for Strix’s growth ambitions. 

Taking into account its already commanding 38% share of the global market in which it operates, low valuation (12 times forecast earnings) and chunky 4.2% yield — made possible by its strong cash flow conversion — Strix remains a mighty tempting proposition.

Pet play

Although offering nowhere near the same kind of payouts, I’m equally bullish on the medium-to-long term prospects for veterinary services provider CVS Group (LSE: CVSG). That’s despite the share price taking a battering since last November after the company revealed it was experiencing difficulty in recruiting clinicians in the aftermath of the EU referendum result. The fact that management has already sounded a cautious note on full-year earnings (to be revealed in September) hasn’t helped sentiment.

Temporary issues aside, CVS still smacks of a quality company in a fragmented industry. In addition to owning a huge estate of veterinary surgeries, the Diss-based firm also has an online presence (selling food and medicines) and a number of pet crematoria, giving it a diversified earnings stream. Since we can safely assume that people will always spend money on their furry friends,  this appears a far safer destination for your cash than many expensive, high-growth plays.

At almost 21 times earnings, CVS’s stock is still worth paying up for. Should things get worse before they get better, it’s surely time to get greedy. 

Dull but decent

It might not hit the headlines but I think XPS Pensions Group (LSE: XPS) is another great pick for investors wanting a bit more stability in their portfolios, especially as its line of business will always be in demand. The product of the recent merger between Xafinity and Punter Southall, the £350m cap is now the UK’s largest pension consultant and administration firm.

Based on a predicted 160% rise in earnings per share, XPS shares currently change hands on a P/E of just under 17. A PEG ratio of 1, however, suggests great value for all the growth on offer.

It gets even better. While the nature of the sector that XPS operates in means that its share price won’t exactly double overnight, the 4% yield should appeal to those looking for dependable income. Based on analyst projections, this payout is likely to grow to a juicy 4.6% next year.  

For those committed to pursuing the dream of early retirement, XPS may do your chances no harm at all.

The post 3 secret stocks for low-risk investors appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

For a lot of us it’s not about the money per se, it’s about having the opportunity to do what you desire with the only commodity that’s truly finite. Made an ill-advised purchase? You can earn that money back.  Waste time and you’ll never see it again.

Of course, a lot of personal finance column inches are devoted to how people should behave to achieve independence. Given that what you don’t do that can be just as important — and arguably more so — than what you do when it comes to investing, that may seem a little odd. Let’s redress the balance somewhat.

Sit in cash

As an asset class, cash is as safe as you can get. So long as your bank doesn’t go bust, you can get up every morning safe in the knowledge that your balance will be the same (or at least reassuringly similar) as when you logged off the night before.

When it comes to achieving your financial goals, however, what’s ‘safe’ is rarely good, at least over the long term. 

You don’t need me to tell you that our savings have been (and still are) held back by historically low rates of interest. The best instant access Cash ISA currently pays just 1.3% in interest, for example. As inflation picks up, this return will likely look even worse as the value of your savings is eroded. 

To be clear, I’m not against having some money in the bank. If you’re considering a big purchase over the next few years, or saving up for a house deposit, it makes absolute sense to keep this accessible. Thanks to the predictable unpredictability of life, some kind of emergency fund is also an eminently prudent thing to have. Broken boiler? No problem. Sudden redundancy? These things happen. 

But if you’ve more than, say, six months of expenses tucked up in an account and aren’t saving for a big purchase, you’re probably being cautious to the point of doing serious damage to your wealth. Don’t expect your future self to be grateful.

Buy index trackers

I’m a big fan of index trackers and, like Warren Buffett, believe the vast majority of those who have little interest in the stock market would benefit from devoting the core of their portfolio to these passive vehicles. 

In addition to the instant diversification they bring — a FTSE 100 tracker simply means you own a bit of each of the UK’s biggest 100 companies — a huge benefit of these and exchange-traded funds are their low-cost nature. Given that you are only intending to generate the market return on your money (minus tracking error and fees), there isn’t any reason for paying over the odds and these funds are priced accordingly.

While this strategy will allow you to build a decent nest egg over the long term, however, it will not necessarily lead to early retirement. That’s fine if you love (or tolerate) what you do for a living and just want to plan for your twilight years.

Those who can’t bear the thought of continuing to run the rat race for decades, however, will need to outperform the market. And to earn better returns than the market, you’re going to need to zig while most zag. Which brings me to my final point. 

Ignoring your risk level

If you were to ask me what my biggest regret from my early investing days was, it would be ignoring small-cap stocks for too long, particularly those showing the potential to grow earnings at a furious rate.

Sure, leaping headfirst into the small-cap universe and furnishing your portfolio with a smattering of oil and tech stocks from the outset isn’t advised. Unless you naturally possess a zen-like temperament, the huge volatility of such stocks increases the likelihood that you’ll sell everything at the first whiff of trouble. This might help you to avoid huge losses but, unfortunately, it also stops you from reaping the rewards when companies recover and flourish. For this reason, I totally understand why most people feel more comfortable picking shares from the market’s top tier in the early days.

The problem with favouring giants over minnows for too long is that the former’s sheer size prohibits fast growth. As legendary investor Jim Slater declared, ‘elephants don’t gallop‘. In other words, don’t expect your money to double in a couple of months if you’re invested in a plodding FTSE 100 giant. Small-cap stocks? That’s a completely different story.

Want an example of just how profitable these firms can be? I assume you do. 

Back in 2001, a young fashion company — As Seen on Screen — listed on the Alternative Investment Market. In September 2003, shares were changing hands for under 4p each. Thanks to the phenomenal popularity of online shopping, the very same business, known simply as ASOS, now has a market capitalisation of £5bn. At the time of writing, its share price stands at a little over £60. Many early investors, even those with what we would regard as relatively modest holdings, will be multi-millionaires.

Of course, I’m cherry-picking here. For every ASOS there are many hundreds of companies who fall apart or fail to perform as well as hoped. Nevertheless, this example shows that searching for fast-growing, high-quality, under-researched stocks toward the lower end of the market spectrum has the potential to be very profitable. Far more so than the returns generated by your typical FTSE 100 behemoth.

Bottom line? Achieving financial independence early need not remain a pipe dream but it can depend on embracing capital risk early in your investing career, thus allowing sufficient time for winners to flourish and any losers to be compensated for. Ignore or underestimate your willingness to take risks and your time in the stock market could be a lot longer than you intended it to be.

The post WARNING! You stand little chance of retiring early if you make these mistakes appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

So, as we say ‘”cheerio” to 2017 and greet the New Year with a nervous nod of the head, here are 10 things you need to be watching out for.

1. Skipping on research

Buying any company without some understanding of how it makes its money is asking for trouble. Make the effort to read its recent reports. Click here if you simply can’t be bothered.

2. Ignoring alternative views

Thorough research involves asking why an investment or company may fail as much as why it may succeed. Taking a balanced approach ensures we avoid falling in love with certain businesses and become blind to the risks of owning them.

3.  Not diversifying

Investing heavily in just a few stocks could bring about life-changing wealth but it requires luck and nerves of steel. If this sounds too risky (and for most people, it is), stick to building a portfolio of quality companies diversified by geography and sector.

4. Not investing according to your own risk tolerance

Understanding your attitude to risk is vital if you’re to reach your financial goals and not be scared away from the stock market. There’s simply no point buying shares in an infrequently traded, ‘jam tomorrow’ company if you’re not prepared for a bit of volatility along the way. Struggling to sleep at night? You’re doing it wrong.

5. Not using up your ISA allowance

Failing to take advantage of your annual ISA allowance is a big no-no, even if you have nowhere near the maximum amount of £20,000 to invest in 2017/18. Build a wall around your profits. 

6. Not keeping track of fees

Regularly buying and selling shares sounds like fun but — thanks to commission fees and stamp duty — it’s also costly. To reduce your susceptibility to over-trading, consider keeping a log of all your expenses. If the costs begin eating into the gains from your portfolio, question your approach.

7. Assuming that cheap shares signify value

Many large companies suffered significant falls in their share prices over 2017. Don’t assume that these are now worthy of investment without doing appropriate research (see Habit 1) — they could have further to fall. Conversely, don’t be fooled into thinking expensive stocks can’t continue rising. 

8. Not running winners

Thanks to our tendency to snatch at profits, failing to stick with our best-performing stocks can be very bad for our wealth. If the story hasn’t changed (and the valuation hasn’t entered bonkers territory), why not hold on?

9. Ignoring your investing time horizon

A person’s investing time horizon will depend on their financial goals. Those wishing to buy a house in five years should probably stick to less volatile assets. Those investing for retirement several decades away can afford to have a far greater proportion of their wealth in equities. On a long enough timeline, a few down days/weeks/months really won’t matter.

10. Assuming that acting is better than not acting

Investing is one of the few areas in life where inactivity often translates to better performance. Before taking action on your portfolio, consider whether your motivation for doing so is based on nothing more than boredom. If so, it may be better to sit still.

The post 10 bad habits to kick in 2018 appeared first on The Twelfth Magpie.

More reading

• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?
• How much do you need in a Stocks and Shares ISA to aim for £375 a week in retirement?

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

It may therefore be wise for investors to protect their portfolios against the shock of leaving the EU by buying stocks that could benefit from a “leave” vote.  With this in mind, I’ve selected these three stocks: Royal Dutch Shell (LSE: RDSB), BHP Billiton (LSE: BLT) and Standard Chartered (LSE: STAN).

Foreign income

You may be surprised that I have chosen three rather cyclical stocks, but because these companies earn an overwhelming majority of their income outside of the UK, they are somewhat shielded from the potential effects of Brexit on domestic economic growth. Moreover, they will benefit from the likely slide in the value of sterling.

Leaving the EU would almost certainly bring about an immediate slide in the value of the pound – it’s such a serious risk that the Bank of England has already drawn up contingency plans to deal with the anticipated sudden outflow of sterling assets. Analysts from investment bank UBS even think Brexit could cause the pound to fall to parity against the Euro in a matter of months – that’s potentially a near 25% fall in the value of sterling.

But a weaker pound would mean income earned in foreign currencies would translate into a higher sterling value – thereby boosting earnings and dividends.

Political uncertainty

Although a potential fall in the value of the pound is positive for companies with large foreign currency incomes, investors also need to consider the risk of political uncertainty from leaving the EU. A vote to leave the EU would likely lead a two-year period of negotiations. And during this period, businesses would face considerable uncertainty about the future ease of doing business across borders.

Even though these companies conduct most of their business outside of the UK, as UK-domiciled companies they would still be confronted with increased regulatory and legal uncertainty. Faced with such risks, investors could consider UK equities as more risky investments – possibly offsetting much of the benefit of a weaker pound.

Other considerations

These stocks may be good bets on Brexit, but investors should always take into account other considerations, particularly longer term fundamentals and valuations.

Shell has a tempting 7.5% dividend yield, but its earnings are heavily exposed to commodity price risks. Oil prices recently breached $50 a barrel, but the recovery does not seem sustainable with the continued supply glut in global markets. Furthermore, Shell faces headwinds in downstream profitability, which could undermine free cash flow generation and raise questions over its dividend sustainability.

Like Shell, BHP Billiton relies on a sustained recovery in commodity prices, which does not seem all that likely. The price of iron ore, which soared more than 60% between the start of the year and late April, is on the decline again. Prices have already fallen by more than a third from its peak, and further losses are possible.

Standard Chartered, the emerging markets-focussed lender, has to contend with the economic slowdown in Asia, which is resulting in lower profitability. On a P/B valuation, the stock is tempting, with the bank trading at 0.5 times book value. Unfortunately, it will take many years for earnings to recover, and its current forward P/E of 26.9 does not appeal to me.

The post EU referendum: protect your portfolio with Royal Dutch Shell plc, BHP Billiton plc & Standard Chartered plc appeared first on The Twelfth Magpie.

More reading

• Down 7% to around £19! Is now the time for investors to consider this FTSE 100 banking giant’s deeply-undervalued shares?

Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

We can mitigate the risk by not putting all our eggs in one basket and instead, by keeping a diversified portfolio. If a company that crashes accounts for 50% of your stock market investments, you’ll suffer a lot more pain than if it’s just one stock out of 10 or 15 or so.

But if you ‘diversify’ through buying shares in 10 different companies in the same sector (for example oil exploration), then you can still be in deep trouble if the sector suffers a calamity. The answer, of course, is to spread your cash across companies in different sectors.

Easy enough?

That sounds simple, but there are some easy mistakes that people regularly make, and the biggest is to over-diversify (or ‘di-worse-ify’ as some people call it). The problem is, the more you diversify the lower the incremental benefit gets. Your second share will make a big difference to your safety, but the 10th a lot less.

It’s been academically tested too. Two researchers in the 70s by the names of Edwin Elton and Martin Gruber measured what’s called the “standard deviation” of annual portfolio returns depending on the number of individual investments they held.

By the time the 10th share is added, they found there’s really not much benefit, by 20 shares even less, and by 30 shares there’s pretty much no benefit at all. In fact, by that stage you’re very unlikely to do better than an index tracker, so you might as well just get one of those instead and save on the effort.

Don’t buy junk

Another mistake comes from buying a poor share just for the sake of diversification. You might have, say, shares in 10 companies that you really like but end up buying several more in which you have less confidence just to make up the numbers. And that very much goes against the core Foolish principle of understanding what you’re investing in and only buying shares that genuinely satisfy your investment criteria.

So what’s the best number of shares to hold for diversification purposes? I’d say it depends on your approach to risk. If you don’t mind a bit of risk, then five or so shares from diverse sectors will make a significant contribution to safety. But if you’re really averse to risk, then I think around 15 stocks really is about the most you’d need.

Portfolio

But what should you buy for a diversified portfolio? That depends on your strategy, but to start I might suggest a bank like Lloyds Banking Group, an out-and-out dividend share like National Grid or SSE, an investment in oil like BP or Royal Dutch Shell,  a long-term pharmaceuticals prospect like GlaxoSmithKline or AstraZeneca, and (seeing as I don’t mind a bit of risk) a strong growth candidate like ARM Holdings.

To take it towards 10, perhaps a solid insurer like Aviva and a global household goods maker like Unilever, but then I’d be struggling on the diversification front because I prefer to choose shares on their own merits in isolation rather than on what diversity they might provide.

The post Why You Should Diversify Your Investments appeared first on The Twelfth Magpie.

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Alan Oscroft owns shares in Lloyds Banking Group and Aviva. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended ARM Holdings, AstraZeneca, GlaxoSmithKline, and Royal Dutch Shell. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.