HPQ Reminds Us of Single Stock Risk

by Jay Pestrichelli on November 20th, 2012

Unfortunately Hewlett-Packard reminds us how unpredictable events can damage a stock. In case you were unaware of today’s news, HPQ reported a “huge accounting charge related to allegations of fraud” as read in the CNBC article Hewlett-Packard Walloped by Charge Relating to Fraud.  We've written on this blog before about HPQ and have been the unfortunate holders of some bullish positions for this symbol. Of course our position is hedged, so our losses are capped, but let’s face it, no one likes to use their insurance.
 
We define single stock risk in our book as the risk associated with a specific but unexpected event that can occur to a single company. After today, it has now happened twice to HPQ. The first was a few years ago when the CEO was having an affair with a company contractor and had to quickly resign. It actually is THE example I use when explaining to people how unpredictable events can devastate a stock’s price. I’m floored that it has happened again to HPQ, but when it rains it pours. Quite frankly, I'm not sure why the market is punishing the stock as badly as it is considering this acquisition was already discounted by analysts AND not executed with the current management team. However, as we know, the market always punishes bad news.
 
Back to single stock risk. Typically we use ETFs or indexes to avoid single stock risk. The theory is that being diversified over a portfolio of stocks will reduce the impact of single stock event. For example, today HPQ is down 12% but the Dow Jones Industrial Average (of which HPQ is one of 30 stocks) is only off 0.2%.
 
But don’t let single stock risk scare you away from ever investing in a stock again. We suggest that 10% to 20% of your portfolio be invested in your Inner Guru picks and that will most likely be individual stocks. If you can remember rule #1 and hedge every investment, then you should take a shot on some symbols. What’s the worst that can happen? Oh I know…the stock could turn out to be HPQ.


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