It’s A Small World After All

A superb way of creating a diverse collection of top-quality investments.

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Like you, I love cheap shares but I haven’t quite figured out how to get them for free. But I can tell you about the next best thing: diversification.

As the saying goes, diversification is the only free lunch in investing. There are an abundance of choices to consider for building your wealth and generating income. Shares. Bonds. Rental Property. Foolish investors should carefully consider all of their options as they determine the asset allocation that best suits their needs.

With respect to share ownership, I, along with my distinguished colleagues at Share Advisor, believe that Fools should own at least 15 different shares and look to own different types of businesses.

This is all about controlling the risk in our portfolios while we pursue long-term returns. For example, it would simply be too risky to own 15 retailers all operating within the UK because they are all exposed to the exact same economic factors, such as the unemployment rate and consumer spending trends.

Instead, Fools should seek to own a balance of manufacturers, financials, pharmaceuticals, telecoms, retailers, and so on. You get the idea.

There’s no right answer to how many of each you should own. A simple common sense approach keeping in mind the 15-share target is sufficient to manage your risk through diversification. And if you find more shares than 15 that you want to buy, all the better. There’s no upper bound on how many shares you can own.

Look to the East

However, diversification involves more than just industry exposure. I believe in geographic exposure as well, simply because it allows a multi-national company to benefit from some of the countries in which it operates having strong economic performance while others may be weak.

In recent years, Asia is where the action has been at, particularly while Western economies go through their slow recoveries from the financial crisis. China deserves special mention as the world’s second largest economy. Euromonitor expects China’s economy to average 9.5% growth for the decade 2010-2020, overtaking the U.S. as the world’s largest economy.

It can be difficult for companies to build a profitable business in a foreign country due to the different consumer tastes and business regulations, but companies that can pull it off and take advantage of the growth in emerging markets are very compelling long-term investments in my view.

I find these businesses to be more resilient than companies exposed to the business cycle in one country. For a geographically diversified company, you’ll often find if sales in one region, such as Europe, are flagging, that sales in another, say Asia, are booming. The overall impact is that a company like this can keep growing at a modest rate from one year to the next.

It is this approach that led me to recommend a financial software provider and a specialist pharmaceutical player to Share Advisor members. So far, these shares have performed well since recommendation, and I expect them to keep on winning as they boost their revenue through expansion into emerging markets like Brazil, China and India.

Next global share

I can’t tip all of the shares I have my eye on, but I can tell you the characteristics I’m looking for as I research my next Share Advisor recommendation.

My checklist includes:

  • Profitable operations in at least three different countries
  • A cash-rich balance sheet with a cautious approach to using debt
  • High returns on invested capital
  • Shareholder-friendly management

One company that meets all of those criteria is ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US), the leader in microprocessor designs for energy efficient applications like smart phones and tablets. If you own an iPhone or an iPad for example, the chips in those devices were designed by Apple under an intellectual property license from ARM.

My only reservation about ARM is the valuation on the shares. It’s just not in my nature to pay 70x earnings for a share. Even if I really admire the business, which I do in this case. My investing style is to put a share like this on my watch list and be patient.

Another share on my watch list that fits the global investing theme is spirits leader Diageo (LSE: DGE) (NYSE: DEO.US). The company does have approximately £10B debt on its books, but with a debt/EBITDA ratio of just 2.6x and an interest coverage ratio of 7x , it can readily service its financing commitments.

Diageo is a wide-moat business with a portfolio of top spirits brands and a distribution system that is tough to match. Like ARM Holdings, Diageo is a share I’d love to own but it’s on my watch list now because of price.

We believe this to be a recipe for investing success.

If you want to build a portfolio brimming with quality business at good prices, let me help you through Share Advisor.

You see, the service currently has more than 20 ‘buy’ recommendations on its scorecard and I am convinced those recommendations offer a superb way of creating a diverse collection of top-quality investments that could easily produce significant long-term gains.

You can see for yourself the potential of these share recommendations by clicking here and joining Motley Fool Share Advisor today.

> Charly does not own shares in any of the companies mentioned.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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