The stock market is inherently a dangerous place for investors, who often become committed to a few well-known companies. Attempting to diversify a small portfolio by capturing exposure to a sector through a single company, investors often manage to diversify solely in a “horizontal” fashion. They’ll take one company that specializes in oil, one in finance, one in consumer discretionary, etc.
What can be often neglected by investors is the diversification of a portfolio in a “vertical” sense. A vertical pairing is essentially attaching a company that holds the future of the same industry or that of a corollary sector. Just as people save for daily expenses in the present, they also tend to think ahead and save for longer-term goals. This is because people want to be prepared and able to address the world tomorrow, while still living in the world today. In the same sense, vertical diversification strives to capture the shifting changes within an industry to prevent being caught off guard when the change begins to occur.
Do you like Amazon (AMZN) as the trend shows a migration of consumers moving towards online shopping? Why not pair it together with big brother Wal-Mart (WMT), who continues to steadily pay out a dividend and has proven to be a refuge of safety during the rough times? Combined, you’ve covered your retailers section in a diversified portfolio while providing additional vertical protection.
Do you think Solazyme’s (SZYM) ability to create green oils for food, chemicals, and fuel holds the promise of a energy-independent tomorrow? Why not add big brother Chevron (CVX), who as an investor in the company, also has its primary operations in the large oil fields the world is so heavily dependent upon? After all, the share price of biofuel makers tend to move in a corresponding manner to the price of oil.
Do you think ARM Holdings’ (ARMH) brand as the premier microprocessor maker for tablets, holds the future in the micro-chip industry? Why not tag along big brother Intel Corporation (INTC), who’s established position in the chip industry allows it to paying a steady 3%+ dividend while you wait for that possible evolution to occur? In doing so, you still concentrate on that particular sector for your horizontal diversification while capturing the possible vertical shift.
Some other possible pairings might include:
- AeroVironment (AVAV) and Lockheed Martin (LMT) – One can embrace the future of robotic defense systems of AeroVironment with a traditional supplier of advanced weapon systems found at Lockheed.
- Teva Pharmaceuticals (TEVA) and Pfizer (PFE) – Generic drug manufacturer sweeping up expired patent formulas (TEVA) paired with established biopharmaceutical leader (PFE).
- Green Mountain Coffee Roasters (GMCR) and Starbucks (SBUX) – Fashionable long-term trend being made with the Keurig machine concept? Pair it with the established fast-food coffee giant to make sure you cover everyone who wants their morning fix.
Disclosure: I am long SZYM.