African Potash (LSE: AFPO),Tern(LSE: TERN),Gulf Keystone Petroleum (LSE: GKP) andLgoEnergy(LSE: LGO) all have plenty of potential, buttheres no denying that these companies should come with a warning label.
Indeed, these fourhighly controversial companies could all become multi-baggers in the best case scenario. But if things dont go exactly to plan,African Potash,Tern, Gulf Keystone andLgocould go to zero.
Blue-sky potential
Terninvests in established, private software companies and itssignificant investment isCryptosoft,the only supplier with a market-proven software security product, for Machine-to-Machine (M2M) applications.
According toBeecham Research, security is now theleading 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 marketwill be worth $700m by 2018. Terns market cap is only 11m attimeof writing, so even ifCryptosoft can grab only a tiny share of the M2M market, Tern could be set for the big time.
Similarly,African Potashs shares could surge if the company reaches its full potential. The company has inked threeseparate deals with three separate parties for the supply offertiliser across Africa andholds a 70% interest in La Societe des Potasses et des Mines S.A.
Lgoreleased itshalf-year results yesterday, which showed group profit had increased byover 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 tocutscosts. 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 receivingregular monthly payments from theKurdistan Regional Government. At the beginning of September,Gulf Keystone confirmed that a payment of $15m gross ($12m) net had been receivedfrom 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 pricesstart 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 investorsshouldnt bet the house on these companies. Its fine to devote a small percentage of your portfolio to these companies, but investors need to rememberthe importance of diversification, as it is the key to long-term wealth creation.
Diversification isdefined asa technique thataims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree thatdiversification is the most important component of reaching long-range financial goals.
Optimal diversification
Most studies agree thatinvestors 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.