Evaluating My Stock Diversification

Two years ago this past August I decided to buy my first stocks. It seemed like a good idea; the market was down, I was an economics major-to-be, and I had just taken a personal finance class. I took about $300 and purchased 5 different stocks. Certainly not a complete portfolio, but enough to get me started I thought. The companies I purchased were: Advanced Micro Devices [AMD], Mistras Group [MG], Nevsun Resources [NSU], Pizza Inn [PZZI], and Aurizon Mines [AZK]. (Aurizon Mines was recently sold in the Spring to Helca Mining [HL].)

I won’t go into detail on what price I purchased these stocks, but if you were to look at the historical prices starting around mid-August of 2011 you can find out about how well I’ve done. The purpose of this blog post is to figure out how well I diversified my “portfolio”. (Hint: not well.) This post will look at three things: what sectors the stocks are in, what the “beta” of my portfolio is, and how correlated my stocks are to each other. In a follow up blog post, I’ll use some mathematics to see if the current market price of the stock is under or over valued, and we’ll see if I should sell any stocks. My prediction is my little “portfolio” will be changing dramatically in the next few weeks.

Let’s start by looking at where my stocks are in the industry. A well balanced portfolio will have stocks spread out in order to minimize risk. The exact order of how your stocks are spread out depends on several factors. For example, younger investors can put more money into stocks in small cap stocks. These are typically more risky stocks, so if the stock turns out to be a bust then the young investor has many years to make up the bad luck. An older investor may not want to be so risky and may have a portfolio balanced more with bonds, as these have a lower return, but also a very low risk. While the exact formula for portfolio balance is subjective, a portfolio should absolutely NOT be built as I am about to show you. Behold:

bad stocks

As you can see, 89.89% of my stocks are all in one category, “Cyclical”, which is further broken down by “Basic Materials” and “Consumer Cyclical”. I have the remaining 10.11% in the “Sensitive” category, which is “Industrials” and “Technology”. As you can see I have absolutely zero “Defensive” stocks, and those that I have in cyclical and sensitive don’t even span the entire category. Ladies and gentlemen, this is exactly how you’re not supposed to do it. In terms of spreading your stocks out over different sectors. The danger here goes without saying: if the cyclical sector is bad, then I am toast. Let’s take a look at the portfolio beta and see if that makes anything any better.

A stock’s beta is overly simplified as how risky the stock is. A beta of 1 means that the stock moves exactly with the market. So for example, if the stock market (as a whole) went up 3%, then a stock with a beta of 1 would go up 3%. Stocks with a higher beta than 1 are more risky and would go up more than 3% (and if the market would go down 3%, the stock would go down by more than 3%), and stocks with a lower beta than 1 would go up less than 3% (if the stock market went down by 3% this stock with a beta smaller than 1 would go down by less than 3%). Here I have a list of my stocks, and the percentage that they take up in my portfolio.

stock beta


The yellow highlighted “Sum” is how risky my “portfolio” is. 1.24 means of course that my portfolio (as a whole) has more risk than the overall market. Now the beta of stocks can change, and can be calculated differently depending on your “starting point” of measurement. I simply used the beta given to me by my broker, TradeKing.

The last thing I want to check is how my stocks are correlated with each other. The idea of building a portfolio is of course to minimize your risk. However, if you had a portfolio full of stocks that all moved with each other, than you would not be minimizing your risk at all. A good portfolio will have some stocks that go up while others go down. If two stocks are selected and one stock moves up the other moves down by the same amount these stocks are perfectly negatively correlated, and will have a value of -1 (this off-sets the risk). Two stocks that have no correlation will have a value of 0, and two stocks that move in sync with each other will have a correlation of 1. I won’t get into the math behind it all, but here’s a few examples of correlation between different stocks in my portfolio:


Now, ideally you would look at correlation between all your stocks you are purchasing as a whole (multiplying each stock by its weight in your portfolio). I simply just wanted to compare a few here, and especially make note of the dangers of stacking your portfolio with stocks that are positively correlated. Take a look at NSU and HL. They make up way too much of my portfolio AND are have correlation (which of course makes sense since they are part of the same industry). If you have stocks that correlate you better be pretty confident that they will do well, otherwise they will cancel out any other negative correlation you have (in my case because NSU and HL make up such a large percentage of my portfolio, it hurts even more if they don’t do well.)


Anyway, that’s the blog post for tonight. I hope you’ve found it interesting and have learned a thing or two. I know I have. Be on the look-out for a few more blog posts soon! I have drafts of minimum wage written and will be working on a post on faith.

Looking at Genco Shipping

The past few days in finance we have been learning about capital structure and how there is an optimal ratio of debt to equity that maximizes stock price. The debt to equity ratio is a fascination subject that I promise to get to in a blog post very soon, but first I want to cover a company, Genco Shipping (GNK) and talk about their operating leverage.

If you’re unfamiliar with the term operating leverage, don’t let it scare you. Operating leverage can be defined as what percentage of the company’s costs are fixed. If a company’s costs are mostly fixed (for example, a lease on a building would be a fixed cost. A company must pay the lease every month.) the company is said to have a high degree of operating leverage. I bring this up because today in my finance class we talked about the company Genco Shipping. You have probably never heard of Genco Shipping. Genco is in the industry of shipping dry goods and heavy metals across the various oceans of the world. Their website is nothing special, and they don’t do home deliveries like UPS or FedEx. Although you have never heard of them, Genco was at one time (very recently) at the top of the world with a stock price around $85 dollars per share. This high market value only lasted until the recession and now Genco sells for about $2.50 per share. But why? Did the financial crisis impact Genco that badly? How Genco is leveraged will help explain their dramatic drop in stock price, and could also provide valuable insight for a good stock buy.


We’ll start by taking a look at Genco’s income statement for the past four quarters. Below you can view Genco’s income statement. Take a look at what I’ve circled in red. These are the company’s costs over the past four quarters. Notice how they are all relatively the same and don’t change much from time period to time period. This means that the costs are fixed. If these were variable costs than the company would scale back whatever is costing so much in order to save money. However, Genco does not have this option.You’ll notice too that the sales of the company have been increasing the past three quarters, from 40 to 46 to 59. More on this a little further down; let’s continue to look into the company.



I have made a little Excel spreadsheet to take this data and make it a little bit more usable. What we see here are rounded numbers of the performance of the company in Quarter 1 and Quarter 3. I have averaged the fixed costs these so that we can use the same amount in each quarter just to make life easier, and we can carry these numbers through our theoretical quarters we’ll get to in a second. Right now you can see I have Quarter 1 and Quarter 3 plotted. Think of these as “Really Bad” and “Bad” quarters. We have noticed that there has been an upward trend in sales the past few quarters, so this should naturally make us curious about “what if” the company broke even or even posted a profit. What would be the stock price? Further more, if the company had a “Good” and “Really Good” quarter, where would that leave the stock price?


In the Excel above we see the stock price if the company breaks even. Now I do know that an earnings per share of >$0 is technically doing better than breaking even, however a revenue of $100 was selected since it’s a nice round number. After all, even with a revenue of $100 the company just barely manages to do better than break even. What we see now is after breaking even, the company has a stock price of about $5.60.


Above we now have some numbers plugged in for a “Good” quarter (which has revenue just over 10% greater than the break even point). Because the company’s costs are all fixed, they do not change even though the company is creating more sales. This leads to a much greater profit margin. For the good quarter the company has a price to earnings ratio of 15 (the market average) which yields the stock price to be just under $18.00. If we take this further and the company has a “really good” quarter than we see the stock price soar to over $60.00. With most companies cost of sales increase as sales increase, keeping the profit margin relatively the same. However with a highly leveraged company, the cost of sales is always going to be relatively the same, so as sales increase, profit margin increases as well.


Let’s conclude this lengthy post by looking again at the sales revenue the past three quarters. Sales revenue has been rising: $40, $46, and $59. Above I have an index chart for the BDIY. The BDIY is a benchmark for dry shipping rates, exactly the industry that Genco is a part of. We could say that this graph shows how much Genco gets paid to ship items. As you can see, the shipping rate has been increasing for most of the year, and it correlates with Genco’s increased revenue each quarter this year. The shipping rate has taken a slight dive recently, but all indexes are vulnerable to some volatility. If the BDIY continues to increase you could see Genco make a comeback, along with their stock price. I do however, also want to mention that this company is a big risk. Interest on debt is almost 40% of their sales for this past quarter. Even though Genco has made better revenues the past three quarters, they have had such a large interest payment compared to sales for such a long time that if shipping rates don’t continue to increase, the company may go bankrupt. The stock closed today at $2.70, if you have some insights to trans-oceanic shipping and feel good about it, it may be worth spending a small sum of money on a few shares and seeing where it takes you in a few quarters.

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