How to Play: Am I Diversified (Diversifying your Stock Portfolio)

In Jim Cramer's CNBC TV show, "Mad Money", Jim Cramer has a segment where callers call in and mention their top five holdings. Jim Cramer then analyzes the stocks, and determines whether or not the caller's portfolio is diversified. Many other people on the social networking site Stockpickr.com ask the same question. But is there a way to determine on your own whether your portfolio is diversified or not? Definitely!

Sector Diversification

The main focus of "Am I diversified?" focuses on sector diversification. Many companies and analysts may have some variations, but there are around ten major sectors:

1. Basic Materials: These include gold, copper, composite material, chemicals, industrial metals, mining, forestry and paper companies such as FCX (Freeport McMoran), and ATI (Allegheny Technology).
   
2. Consumer Discretionary: Consists of General Retailers, Media, Travel and Leisure, Food and Drug Retailer companies such as TGT (Target), DIS (Disney), BBY (Best Buy), and SBUX (Starbucks).
   
3. Consumer Staples: Consists of Household Goods, Beverages, Food Producers, and Tobacco. Some others (such as those at ishares.com ) would include Automobile Parts, and Leisure Goods. Examples include PEP (Pepsi), MO (Altria), PG (Procter and Gamble), and SLE (Sara-Lee)
   
4. Energy: Consists of Oil & Gas Producers, Oil Equipment and Services, Coal, and Alternative Energies (such as Solar). Stocks include XOM (Exxon-Mobil), SLB (Schlumberger), and BTU (Peabody Energy).
   
5. Financial Services: Consists of National and Regional Banks, General Financial companies, Brokerages, Exchanges, Nonlife Insurance, Real Estate, and Life Insurance Companies. Examples include WFC (Wells Fargo), GS (Goldman Sachs), NYX (New York Stock Exchange-Euronext), AMTD (Ameritrade), PGR (Progressive Corp).
   
6. Healthcare: Consists of Pharmaceutical, Biotechnology, Health Care Equipment and Services, Healthcare Insurers. Examples include PFE (Pfizer), JNJ (Johnson and Johnson), MDT (Medtronic), GILD (Gilead Biotech), UNH (United Health Group), ISRG (Intuitive Surgical)
   
7. Industrials: Consists of General Industrials, Aerospace and Defense, Support Services, Industrial Engineering, Industrial Transportation, Electronic and Electrical Equipment, Railroads, and Construction and Materials. Examples include GE (General Electric), BA (Boeing), CAT (Caterpillar), UPS (United Parcel Service), UNP (Union Pacific Corp), DE (Deere), WMI (Waste Management), FLR (Fluor Corp), MDR (McDermott), and TEX (Terex).
   
8. Technology: Consists of Hardware, Software, Semiconductor, Internet, Networking, and General Technology Companies. Examples include MSFT (Microsoft), CSCO (Cisco), GOOG (Google), AAPL (Apple), IBM (IBM), INTC (Intel), NOK (Nokia), and RIMM (Research in Motion).
   
9. Telecom: Consists of Fixed Line and Mobile Telecommunication Companies. Examples include T (AT&T) and VZ (Verizon Communications)
   
10. Utilities: Consists of Electricity, and Gas, Water and MultiUtilities. Examples include EXC (Exelon Corp), TXU (TXU Corp) and DUK (Duke Energy).
    

How to Sector Diversify

So what you can do is look at each stock in your portfolio, and categorize them into one of the sectors above. After you go through your entire portfolio, you may find that some stocks may be grouped into a single area. For example, you may hold NYX (New York Stock Exchange-Euronext) and GS (Goldman Sachs). While one is a Stock Exchange, and the other is a Broker, both are grouped in the Financial Services Sector.

There are some companies that may be difficult to pin down to any one sector. For example, AMZN (Amazon). Is it Consumer Discretionary or is it Technlogy? Use your best judgement. If you want, during your analysis, you can put 50% of Amazon under Consumer Discretionary, and 50% of Amazon under Technology.

Sector Diversification is the main form of diversification preached by Jim Cramer.

Other forms of Diversification

Sector Diversification is not the only form of diversification. There are many other forms of diversification.

Market Capitalization Diversification

Companies have different market capitalizations. Some are very large companies (large market capitalization) like GE (General Electric), while some others, are small or mid capitalization companies such as NTRI (NutriSystem). Stocks of different market capitalizations behave differently from each other.

Growth and Value Diversification

Some stocks are considered Growth Stocks. Investopedia defines a Growth Stock as one whose "Shares in a company whose earnings are expected to grow at an above-average rate relative to the market."

Some other stocks are considered Value Stocks. According to Investopedia, a Value stock is "A stock that tends to trade at a lower price relative to it's fundamentals (i.e. dividends, earnings, sales, etc.) and thus considered undervalued by a value investor. Common characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio."

So within a portfolio, you can further diversify by holding different styles of stocks from growth to value.

Peter Lynch, in his Book, One Up On Wall Street, further groups stocks into six categories:

1. Slow Growers
   
2. Stalwarts
   
3. Fast Growers
   
4. Cyclicals
   
5. Turnarounds
   
6. Asset Plays
   

International and US Diversification

Another way to diversify your portfolio is to hold stocks that are based in the United States, or based internationally. With international stocks, you can further group them into Developed International Markets such as Europe, Japan, and Australia, or into the Emerging International Markets such as Taiwan, Korea, China, Brazil, India, Eastern Europe, Africa, Middle East, and Russia.

Speculative and Non-Speculative

In his books (such as "Real Money: Sane Investing in an Insane World") and his shows, Jim Cramer preaches that up to 20% of a (discretionary, not retirement) portfolio could be allocated to more speculative stocks. This is yet another form of diversification.

Conclusion

So in order to have a diverisfied portfolio, be sure to diversify across several industry sectors as mentioned above. You can also choose to diversify in other ways as well such as market capitalization, growth vs. value, speculative vs. non-speculative, US vs International Diversification.

Losers of the Digital Living Room Revolution

There will be losers in the Digital Living Room Revolution.

1. LOSER: DVD retailers (even HD-DVD or Blu-Ray?):

REASON: Video on Demand may become so prevalent, people will choose to download movies instead of drive to their neighborhood Blockbuster, or even to their mailbox to pick up movies from Netflix. Even DVR maker Tivo (NASDAQ: TIVO) has a current system with Amazon to download shows directly to the Tivo box.

TIME FRAME: I think Netflix (NFLX) is still viable at this time, and maybe Netflix may still be viable because they can mail HD-DVD and BluRay DVDs. Video on Demand is still in the innovation and early growth stages and will need much greater adoption before DVDs become obsolete.

2. LOSER: Gaming Retailers such as Gamestop (GME)

REASON: Eventually, there will be Gaming on Demand where customers can directly download Games without having to go to a retailer. Companies might even come up with Gaming Servers where customers can log on to the site, and play their game at home.

TIME FRAME: It will be a while before Gaming on Demand becomes big enough to be a big threat to Gaming Retailers such as Gamestop (GME). Since we are still at the beginning of the Gaming cycle (3 major consoles out), I'd buy Gamestop but carefully watch the developments in Gaming on Demand. (author holds: GME)

3. LOSER: Traditional Broadcasters

REASON: As IP Protocol TV (IPTV) becomes more prevalent, broadcast and cable channels will have less drawing power. There will be much more selection and many more choices for the average consumer.

TIME FRAME: We are still very early in this cycle. We are in the innovation stage. However, even traditional browser based entertainment/videos, games are reducing the time people spend watching traditional Broadcasters.

4. LOSER: Traditional Advertisers

REASON: As people adopt DVRs and Tivos in much larger numbers, the power of the traditional advertiser goes down. With DVRs, people can easily forward commercials. TIVO and DVR users usually gush over the technology and it truly changes the viewing habits of those who use it.

TIME FRAME: DVRs and Tivo (TIVO) are being adopted in greater numbers (though not as fast as the adoption of the VCR?). By 2010, it is said that 30% of US households will adopt it.

5. LOSER: Traditional Desktop PC manufacturers?

REASON: As the Digital Living Room becomes more advanced, and as more internet activity moves towards the digital living room, less people may be using their Desktop PC. Digital Living Room Devices such as Tivo (that sit between an HDTV set and the broadband connection) can interact, but do not require the Desktop PC. The nature of these Digital Living Room Device (such as Tivo or a set-top Box or AppleTV) does not necessarily have to be the traditional Microsoft (MSFT) or Apple (AAPL) Desktop PC.

More losers may exist but the above should hopefully give us an idea what may be in store for certain businesses. Those in danger of obsolescence have to act now or they may end up being the dinosaur of the technology world.

Current Contenders in Todays Digital Living Room

When I say Digital Living Room, I am imagining a setup such as this:

1. High Definition TV Set
2. Comfortable seating to enjoy the Digital Living Room.
3. Broadband Connection.
4. A computer like device that interacts with the Broadband connection and the TV.
5. Interaction with a home network or an alternate computer (Optional)
6. Good sound system (nice, but not a requirement)

Before we get to the Digital Living Room of tomorrow, we have to look at today's technology and look at all the current contenders.

Contenders:

1. DVRs and Tivo (TIVO):

DVR is an acronym for Digital Video Recorders. While a VHS recorder recorded in a VHS tape format, the DVR records programs in a digital format in its internal hard drive. DVR's typically have a much better interface than the old VHS system. They normally incorporate a detailed Channel Guide, and a user can typically just choose which program to record very easily without having to manually set start and stop times. Certain other DVRs have much more user friendly features. Many offer to time delay live TV (want to pause the Big Game while you step out and pay the Pizza delivery guy? You can do that). Many offer you to easily forward through prorgams and commercials.

Tivo is a particular type of DVR (along with its software), and is often mentioned as the leader and innovator in the field. TIVO is publicly traded on the Nasdaq. Tivo has many other special features including a special program with Amazon to automatically download programs to the Tivo Box, and special features to access a networked PC's multimedia content including pictures.

2. Set-Top Boxes:

Many cable and satellite companies offer set-top boxes. These often connect directly to the broadband connection and the TV. They often translate the incoming signals (from Cable or Satellite) and send the data to the HDTV set including offering many digital channels and High Definition content. Some have the additional features such as offering video on demand. Some even incorporate a DVR to record programs in their internal hard drives.

DTV (Direct TV) and DISH (EchoStar Communications) are both satellite providers.

CMCSA (Comcast) is a cable provider who offers a set top box with video on demand, HD content and a DVR.

NNDS (NDS Group) and CSCO (Cisco, through their acquisition of Scientific-Altanta) are set top box makers.

T (AT&T) offers AT&T U-Verse, what they market as an IPTV solution. It offers similar functionality to Comcast who offer Video on Demand, Detailed Channel Guide and DVR capability.

Many other companies exist. What I list above are some examples.

3. Gaming Consoles such as Nintendo Wii, Sony PlayStation PS3, Microsoft Xbox:

Aside from being gaming consoles, these consoles can be entertainment centers as well. The PS3 contains a full Blu-Ray Player. Some people even choose to buy a PS3 not for the gaming capability, but to be able to watch Blu-Ray movies (can be cheaper than buying a dedicated Blu-Ray DVD player). The Nintendo Wii, even has the capability of integrating the Opera Internet Browser. Now, with the Nintendo Wii, you can browse the web using the Nintendo Wii controller from the comfort of your Living Room couch and enjoying a large screen HDTV set.

Microsoft (MSFT), Nintendo (NTDOY), Sony (SNE)

4. Windows Media Center

Windows Media Center is a Microsoft (MSFT) produced application that is designed to serve as a home entertainment hub. With tuner cards, Windows Media Center is capable of acting as a DVR. The Media Center can also have access to different media on the PC.

Working with a Windows Media Center Extender, media can be displayed on a display such as an HDTV set. Windows Media Center Extenders are "set-top boxes that are configured to connect via an Ethernet or Wireless network to a computer running Microsoft Windows XP Media Center Edition or Windows Vista Home Premium/Ultimate to stream the computer's media center functions to the Extender device. This allows someone to be able to use the Media Center and its features (such as view photos, videos, listen to music, watch live television and use DVR functions, watch recorded TV, etc.) on their television or other display device." (Wikipedia) The Xbox gaming console can act as a Windows Media Center Extender

5. Apple iTV:

Apple's iTV is a device much like a set-top box that connects directly to the HDTV set. This device can wirelessly (or through wires) sync up through a local computer which contains media including iTunes media. Now instead of watching the media in front of a small computer screen, this media can be viewed directly on an HDTV set in the living room.

AAPL is publicly traded on the Nasdaq.

6. Sling Media's SlingCatcher:

The company which brought you the SlingBox now brings you the SlingCatcher. This device can bring internet content to the Living Room HDTV display.

Sling Media is a privately held company.



More on this subject in the future.