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Why You Can’t Pick Just One Stock

Choosing just one stock to invest in doesn’t put the odds of winning in your favor.

“If You Could Buy Just One Stock … ”

Rare and In Demand

A Speculative Stock

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Stock investors are an energetic and inquisitive group, and all of our analysts at Cabot get questions every day about the market, sectors, stocks, charts, strategies and breaking news stories.

The most common question is just “What do you think of XYZ?” And we’re always happy to give our opinion.

But a question that runs a close second is “If you could buy just one stock here, what would it be?”

In a way, it’s a fair question. After all, we’re stock analysts, and every day we pick a few stocks from the 8,000 or so that trade on U.S. exchanges to recommend to our subscribers. So if we can pick 10 out of 8,000, why can’t we pick the top one out of the 10?

But in another way, the question ignores the very nature of growth investing, which is an attempt to put the odds on your side.

The person who asks for one stock (and only one stock) is like someone asking for a tip on the Kentucky Derby. After all, there are just 20 horses in the Derby, and if you have all the information, you should have a good shot at picking the winner, right?

What the statistics tell us, unfortunately, is that picking one (and only one) horse is a very risky business, even if you pick the favorite.

The Kentucky Derby is the most celebrated horse race in the U.S., with a history that stretches back to 1875, and probably attracts more betting action per minute than any event in the world. If you had bet every year on the favorite, you would have won six times out of ten in the 1890s and the 1970s. Not bad.

But starting with the 1930s, betting the favorite would have given you a winner in exactly 25% of the races. (That number includes zero wins in the 1980s and zero again in the 1990s.) And since the odds on a favorite horse are usually quite low, your winnings in your winning years would be so low that would have ended up well under water with your strategy of playing favorites.

And if you need another illustration of the danger of trying to pick a favorite, consider the case of an editor we’ve read from time to time. He took his daughter’s college fund (which he usually bullets in one stock at a time) and put it all into a call option on a pharmaceutical company. The company was about to get news from an FDA advisory panel on a new weight loss pill, and the father timed his option to take advantage of the positive reaction.

What he got was a series of pointed questions from the advisory panel and a 90% drop in the value of his options.

So, the moral of the story is that it’s not really possible, nor even desirable, to try to pick one favorite stock. The Cabot China & Emerging Markets Report is considered fully invested when it has 10 stocks in its portfolio, which is pretty darned aggressive. And the Cabot Market Letter maxes out at 12 stocks in its Model Portfolio.

What that means is that when I’m asked for my favorite stock right now, I’ll always respond with two or three. Life (and the market) is just too uncertain to pick just one stock.

But if you want to get in on the extraordinary strength of emerging market stocks, a trial subscription to Cabot China & Emerging Markets Report can put decades of Cabot’s growth stock expertise on your side. Cabot China & Emerging Markets Report is the top performing investment newsletter of all the newsletters followed by Hulbert Financial Digest over the last five years. It’s a great way to power up your portfolio. Learn more!

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Headlines about “rare earth elements” or “rare earth metals” are popping up all over the place as China is accused of cutting off the supply of these scarce commodities to Japan in protest over the arrest of a trawler captain accused of fishing in waters controlled by Japan but claimed by China. (China denies the export ban.)

This dispute has focused a lot of attention on rare earths, highlighting how little most people know about them and why they’re important.

I can’t repair the damage you did by sleeping through your high school chemistry class, but here’s a quick refresher (and a stock recommendation, to boot).

There are 17 rare earth elements, and each one has its uses. When cathode ray TV sets were still dominant, the element europium supplied phosphor that produced the vivid red. Rare earth magnets that use neodymium, praseodymium, samarium, gadolinium and dysprosium are much more powerful than standard ones. Lanthanum increases the refractive index of glass, making it a popular addition to camera lenses. Cerium is the catalyst in your self-cleaning oven. Holmium, erbium and ytterbium are used as dopants in lasers.

(It’s not an important part of the story, but I was fascinated to learn that four of the rare earth elements are named after the little Swedish town of Ytterby where they were first discovered. So we have yttrium, terbium, erbium and ytterbium, which has got to create some confusion.)

These exotic elements have other uses as well, but it’s their extensive and increasing use in hybrid and battery-driven cars that is causing tension. China emerged as a dominant producer of rare earth metals in the 1990s, and its aggressive pricing caused the shutdown of many smaller mines around the world.

But with China now producing 95% of the world’s annual production (or 96% or 97%, depending on what you read), things are getting ticklish as China—which now uses about 60% of the rare earths it produces—needs more and more of its own production.

Even leaving out the potential for the use of these increasingly elements as a punishment for those who tick China off, there’s the very real need for rare earths in automotive, high-tech and defense industries in the U.S. and elsewhere.

It takes time to re-open old mines and ramp up production, but that’s exactly what’s happening in many places, including the Mountain Pass rare earth mine in southern California near the Nevada border.

Rare earth deposits often contain thorium and radium, and the radiation from these elements led a uranium prospector to the Mountain Pass deposit in 1949. By the 1960s, the mine was in high gear, producing europium for color TV screens, and heavy production increased through 1995, making Mountain Pass the main source of the world’s supply. But repeated spills of wastewater with radiological contamination (plus the advent of China as a low-cost producer) caused the suspension of separations activity in 1998 and mining operations were shut down at Mountain Pass in 2002.

It has taken concerns about strategic defense needs and the very real possibility that China will reserve more and more of its production for Chinese companies to kick Mountain Pass production back into gear, but that’s what’s happening.

So my stock pick of the week is Molycorp (MCP), which is pumping $500 million into the reopening of the Mountain Pass mine.

Molycorp has actually been processing new output since 2009, using existing stockpiles of the bastnasite ore concentrate left over from earlier operations. But with the infusion of new cash, mining operations are scheduled to resume in 2011.

Mountain Pass has an estimated 2.21 billion pounds of proven and probable rare earth oxides with an average 8.24% ore grade. And Molycorp has a 30-year mining permit (and an associated environmental impact report) issued at the end of 2004.

Molycorp’s bottom line has been a bunch of quarterly losses, to date, which is just what you’d expect from a capital-intensive industry and a development stage company.

But the story is so compelling that the stock, which came public in late July, has already nearly doubled, with today’s China vs. Japan headlines only stoking the flames.

Is it speculative? Of course. It’s a mining operation and the company hasn’t made a cent yet.

If you decide to take a flier on this one, keep it small and average up as you get a little profit cushion to work with. It’s going to be a bumpy—but fascinating— ride.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

Editor’s Note: If Molycorp is too speculative for your investment style, try Cabot Top Ten Weekly, which brings subscribers the best picks in the market each and every Monday. These stocks come with detailed technical and fundamental analysis, as well as a suggested buy range, so you always get in at the right time. Give it a try today!

Paul Goodwin is a news writer for Cabot’s free e-newsletter, Wall Street’s Best Daily.