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Can You Afford To Buy High-Risk Plays Like African Potash Ltd, Tern PLC, Gulf Keystone Petroleum Limited And Lgo Energy PLC?

African Potash (LSE: AFPO), Tern (LSE: TERN)Gulf Keystone Petroleum (LSE: GKP) and Lgo Energy (LSE: LGO) all have plenty of potential, but there’s no denying that these companies should come with a warning label. 

Indeed, these four highly controversial companies could all become multi-baggers in the best case scenario. But if things don’t go exactly to plan, African Potash, Tern, Gulf Keystone and Lgo could go to zero. 

Blue-sky potential 

Tern invests in established, private software companies and its significant investment is Cryptosoft, the only supplier with a market-proven software security product, for Machine-to-Machine (M2M) applications. 

According to Beecham Research, security is now the leading concern for users of M2M devices and the size of the market for security products is exploding. Based on the current rate of growth, the M2M security market will be worth $700m by 2018. Tern’s market cap is only £11m at time of writing, so even if Cryptosoft can grab only a tiny share of the M2M market, Tern could be set for the big time. 

Similarly, African Potash’s shares could surge if the company reaches its full potential. The company has inked three separate deals with three separate parties for the supply of fertiliser across Africa and holds a 70% interest in La Societe des Potasses et des Mines S.A.

Lgo released its half-year results yesterday, which showed group profit had increased by over 150%, from £800k last year to over £2m this year. Oil production was up by 200% year-on-year and to cope with the low oil price management is looking to streamline the business to cuts costs. These actions should help the company weather the low oil price storm and give it solid foundations to stage a comeback when oil prices return to more normal levels. 

Similarly, things are looking up for Gulf Keystone, which is now receiving regular monthly payments from the Kurdistan Regional Government. At the beginning of September, Gulf Keystone confirmed that a payment of $15m gross ($12m) net had been received from the KRG. If the company continues to receive monthly payments of around $12m, it should be able to keep its head above water until oil prices start to recover, then it can target growth. 

Importance of diversification 

African Potash, Tern, Gulf Keystone Petroleum and Lgo Energy all have the potential to be multi-baggers, but investors shouldn’t bet the house on these companies. It’s fine to devote a small percentage of your portfolio to these companies, but investors need to remember the importance of diversification, as it is the key to long-term wealth creation. 

Diversification is defined as “a technique that…aims to maximize return by investing in different areas that would each react differently to the same event.” Most investment professionals agree that diversification is the most important component of reaching long-range financial goals. 

Optimal diversification

Most studies agree that investors can achieve optimal diversification with only 15 to 20 stocks spread across multiple sectors, although many investors prefer a higher number, holding several different stocks from each sector to further increase diversification. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.