Using Concentrated Positions to Create Diversification
We examine how DynaLogic's signals performed on a stock that has continued to rise in price
As Warren Buffet would say, “Concentration creates wealth, diversification preserves wealth”.
Most of our “Just do Something” articles have focused on companies that had a big runup only to see the stock collapse. We demonstrated that a strategy of selling on strength and using the proceeds to purchase shares of the iShares S&P 500 (SPY) worked well and followed the adage “Concentration creates wealth and diversification preserves wealth”.
This maxim can also apply to companies that continue to grow and avoid the huge selloff on the backside of a significant run-up. Let’s take a deep dive on COSTCO to examine this further.
Costco Wholesale Corporation (commonly shortened to Costco) is an American multinational corporation which operates a chain of membership-only big-box retail stores (warehouse club). As of 2022, Costco is the fifth largest retailer in the world and is the world's largest retailer of choice and prime beef, organic foods, rotisserie chicken, and wine as of 2016. Costco is ranked #11 on the Fortune 500 rankings of the largest United States corporations by total revenue.
Costco's worldwide headquarters are in Issaquah, Washington, an eastern suburb of Seattle, although its Kirkland Signature house label bears the name of its former location in Kirkland. The company opened its first warehouse (the chain's term for its retail outlets) in Seattle in 1983. Through mergers, however, Costco's corporate history dates back to 1976, when its former competitor Price Club was founded in San Diego, California. As of February 2023, Costco has 855 warehouses worldwide: 587 in the United States, 107 in Canada, 40 in Mexico, 32 in Japan, 29 in the United Kingdom, 18 in Korea, 15 in Australia, 14 in Taiwan, four in Spain, four in China, two in France, and one each in Iceland, New Zealand, and Sweden. Wikipedia
On January 2, 2020, Costco stock closed at $279.10. On July 17, 2023, Costco stock closed at $552.96, an increase of 98.1%. Let’s see how using the DynaLogic strategy of selling on strength and using the proceeds to purchase the SPY played out.
Price History with DynaLogic Sell Signals
Now let’s see how the two scenarios played out.
While there is a small give-up in total return of -4.7%, this is offset by the increased diversification, with 33.8% now allocated to SPY and 66.2% allocated to COST.
We’ve highlighted many cases where DynaLogic has led to much greater returns, but we want to acknowledge there will certainly be cases where that doesn’t happen. If a stock continues to increase, then of course the return will be higher if you haven’t sold off any shares.
That said, we strongly believe that following the system is still in your best interest. In many cases, there is a sell-off. If Costco drops, this story could very well be different in a few months. An individual stock is much more volatile so leaving your original investment plus your gains in a single stock is much riskier, as there is potential for a much sharper drop than you would see in an ETF or a bundle of stocks.
Additionally, we have shown case studies where you reinvest into the S&P 500. That said, you have plenty of other options. If you had put the sale proceeds from Costco into one of our strong add/initiate signals that we highlighted in this article, your return would have beaten buy & hold. Regardless, being smart and following the system to trim a winner lets you diversify and provides optionality to reinvest the proceeds opportunistically or in a safer bet like an ETF, while also keeping you in that winning stock so you benefit from any future increase.
DynaLogic doesn’t listen to the experts and isn’t swayed by emotions. DynaLogic uses a mathematical algorithm to alert our subscribers to opportune moments to enter or add to a position, and when they need to consider trimming a position.
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