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What a week for Oracle (ORCL) it was; seemingly a bullet proof company, with a great CEO (unless you ask his competitors), continuously growing internally and with insatiable appetite for acquiring competitors. What else could an investor want in a stock? If you are looking for a solid information technology company, Oracle should certainly be on the top list of the companies to invest. Or is it?

In my opinion, a prudent investor needs to be diversified and not be focused on any single company. It is a well-known researched fact, and I have written many times about it, that appropriate asset allocation is key to prudent investing policy. What happened last week with Oracle is certainly a good example of it. It is an important example that being in the right sector is more important than taking a risk of investing in an individual name.

The big announcement of missed earnings brought the company down by 11.66%. The reason was because the company came up with earnings of $0.51 per share instead of average estimate of $0.59. The earnings estimate varied from the low of $0.55 per share to $0.60 (Source: Yahoo Finance).

So 38 analysts follow this company (yes thirty eight!) and all of them got it wrong. Not one had come even close to estimating the earnings correctly. If you think about this, you should really wonder what all these experienced analysts, with significant research resources behind them, are getting paid for.

Now before we get too negative on the analysts, let’s remember that it is a fact of life that companies miss earnings all the time. The analysts typically work with the same information that is mostly public. And although a good equity research analyst will do as much primary research as possible, it is very, very difficult to get a truly deep insight into the company financials and forecast true earnings. Most companies, especially the large ones, have mastered the art of earnings management – so blaming the analyst would typically not be appropriate.

So the question begs to be asked - how does an investor who likes Oracle invest in the company? A simple answer would of course be to buy the company stock directly. If you would have done that, you would know that today your investment would have plunged by over 11%. A better answer is to apply asset allocation methodology and invest in an ETF that includes Oracle, as well as other information technology stocks. By doing so, you diversify your portfolio by reducing your exposure to individual company risk, while taking advantage of Oracle as the chosen investment.

On a very broad level you can start with XLK, the Technology and Telecom SPDR ETF. This ETF includes all 75 technology stocks as well as 8 telecommunications stocks that comprise the S&P 500 Information Technology and Telecommunication Services sectors. Other choices are VGT, the Information Technology ETF form Vanguard and MTK, the Morgan Stanley Technology ETF. Alternatively, if you believe in the equal weighting investment thesis and methodology you can use RYT, the Rydex Equal Weight Technology ETF.

The S&P 500 Technology sector is further subdivided into three Industry Groups: Software & Services, Technology Hardware & Equipment, and Semiconductors & Semiconductor Equipment. So to get exposure to ORCL we need to look at ETFs that are focused on software. These software only ETFs are IGV, and the Software Index Fund from iShares (PSJ). We've also included the Dynamic Software Portfolio Fund from Powershares, or SWH, the Software HOLDRS ETF in our chart below, but note that it is now defunct as of December 23, 2011.

So now let’s compare our investment in ORCL relative to the large cap diversified technology ETFs.

click to enlarge

Source: Yahoo

In this case, except for MTK, an investor would fare significantly better with an investment in the broad technology ETFs such as XLK or VGT. This of course makes sense; by being invested in the broad technology sector and avoiding individual stock risk an investor gets a better risk/reward profile. In other words, you significantly reduce your risk, while still getting investment exposure to ORCL.

If you wanted to get more granular and compare how ORCL has performed against software ETFs, you would see a different picture.

Source: Yahoo

In this case, all the software ETFs track ORCL pretty closely, as opposed to the broad technology ETFs. The graph shows a much lesser diversification value of being invested in the software ETF versus being invested in the broad technology ETF. This is logical because ORCL, as of the end of last month, was 13.5% of the market weight of the software sector versus 6.0% of the total technology sector.

To summarize, I believe we have seen another example how asset allocation works to our advantage by reducing the investment risk and improving the risk/reward profile of our portfolio. Use it wisely and use it often.

Source: Asset Allocation: Oracle Vs. Related ETFs