Do you own the next BP?

John Osbon - April 5, 2011

April 22nd is the first year anniversary of the largest offshore oil spill in United States history.

The tragic 2010 explosion of BP’s Deepwater Horizon rig in the Gulf of Mexico taught difficult lessons about drilling risks, industry regulation, and environmental protection. The spill was also a stark reminder for investors about the dangers of owning the wrong stock at the wrong time.

In the months after the deadly explosion, as the world watched a 24/7 video feed of crude pouring into the gulf, the company’s stock price fell by half. Almost one year later, BP’s price is 25% below its pre-accident price, and well behind the Dow’s recent performance.

 

Graph source: CNBC

One damn thing after another

Things can go wrong, and do so without warning — accidents, lawsuits, product failures, fraud, aggressive competitors, regulatory surprises. The impact on stock prices can be harsh, swift, and, in the worst cases, irreversible. Investing, like history, often seems like a series of unpleasant, unpredictable events.

Despite these dangers, generations of investors have scoured the market for the next GE, Google, or Microsoft and now Apple— a “sure thing” stock that could only go up. Unfortunately, making a sizable bet on any such stock is just that — a gamble. For most investors thinking of the long term, the opportunity for a big win is just not worth the risk of a company-specific disaster.

Spread the risk

Instead, we typically advise our clients to stay out of specific stocks in favor of index ETFs and other investments that offer exposure to many securities within an asset class. Spreading assets over hundreds or even thousands of companies, index investors build a barrier against unknowable one-company disasters.

We feel investors are better served if they forget about trying to divine the next invincible Microsoft, for example, — which, by the way, fell by more than 50% between 1999 and 2010 — and just make sure they don’t own too much of the next BP.

What would you do if crisis struck your number one stock holding?

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