Graduating Yale seniors have an annual tradition of heading down to Myrtle Beach, SC for festivities the week before commencement. That seems to have nothing to do with you as an investor. Except for the fact that this week coincided with the annual “Bike Week,” in which motorcyclists from all over the country head down south to mix, mingle, party, and burn some rubber on the road.

Not surprisingly, all reports have indicated that the majority of bikes were Harley-Davidsons. I say not surprisingly because Harley sports around a 50% North American market share, so one would expect a sample size during Bike Week to result in a similar statistic. But even more so than that, apparently, almost every motorcycle on the road was a Harley Davidson. And there were a lot of them.

I can think of only two reasons why this sample resulted in such a skewed number of Harleys. One great for HOG stockholders, another neutral. The neutral reason would be because of the demographics of the sample size of folks attending Bike Week. That is, Harley owners are typically older males with higher than average median household incomes (average age around 45, median income around $81,000/year). This is not so for, say, Honda or Suzuki riders, who are on average younger than their Harley counterparts. This goes to say that Harley owners would be more likely to attend a function during the middle of a business week since they are more likely to be of retirement or semi-retirement age. Not good news, not bad news. Just a biased sample.

However, another factor contributing to the overwhelming majority of Harleys in Myrtle Beach is, of course, the culture of the Harley owners. Harley has been phenomenally successful at building a lifestyle around its products (hey, it’s the only company I can think of whose brand customers tattoo on their bodies). Through its Harley Owners’ Group, the company has nearly 1.5 million riders actively engaged in a culture which they love to be a part of. They take pride in their ownership, have fun being a Harley owner, and would never think of Honda as their next bike. Thus, it would not surprise me if the vast majority of bikes were Harleys given the strength of the company’s consumer culture vis-a-vis competitors’. And for whatever the anecdote is worth, outside of one Harley-Davidson store, for instance, literally hundreds of bikers swarmed to barbecue, buy apparel, and show off their bikes.

The Honda gathering was nowhere to be found.

Granted Honda had no store, but you tell me: which party would you have rather attended?

I wrote previously about this company (ETLT.OB) in an old post here.

There have been plenty of concerns raised by other bloggers and researchers (see here for instance) about the veracity of the company’s claims, their internal controls, their seeming lack of professionalism, the language barrier, and, of course, the inherent risks of investing in a Chinese company. I’ve been digging through the company’s filings and I’ve decided to attempt to get to the bottom of it and speak with the company myself.

I’ve been in contact with the company’s Investor Relations firm, Heron Public, and have been peppering them with questions as well as trying to arrange a time to speak with the company’s Chairman and CEO (through a translator). I will post the dialogue with Heron and any communications with the executives as soon as possible.

In the meantime, have a look at the company’s 10-K and feel free to forward your own thoughts my way. To rehash the basic thesis, the company seems highly undervalued by the numbers… if, of course, their is nothing lurking beneath the surface. My mission now is simply to better understand the risks involved and get a stronger feel for the company’s management.

I’ve taken a small position in the stock (perhaps against my grain given that I rarely do this under such uncertainty) and will continue to provide progress updates.

I’ve had some lively debates in the past several days on the issue of diversification. The conventional wisdom is that a portfolio should be diversified to limit the risk of any one position blowing up and destroying returns. Diversification is supposed to “smooth” returns and protect one’s downside. But there’s a catch — the more diversified a portfolio, the more it tends to match the market’s return.

Those espousing conventional wisdom would surely balk after taking a look at my portfolio. I own only three stocks, one of which comprises around 50% of the total assets. Plenty of advisers, academics, etc. would probably think I’m nuts, but I’d like to make a case for a different paradigm of risk and reward. I believe that the determining factor in how much one should diversify turns on how much one understands about the stocks in which they are invested. Graphically, this might look something like:

The reason for this is simple. If one understands and properly evaluates the risks of one’s “best” holdings, they incur opportunity costs by allocating capital to more and more investments. This drags down returns and dilutes the investors’ capacity for understanding any particular investment.

Yes, a focused portfolio will increase the standard deviation of returns, but for long-term investors, this should be of no concern. Risk comes in doing something one does not understand more than from fluctuations in price.

None of this is to say that it’s always a bad idea to diversify. Quite to the contrary, for investors who either do not have the time or skillset to evaluate an individual stock, diversifying is probably a good idea. In fact, I’d recommend index funds (extreme diversification) for the average investor who has neither time nor desire to research investments.

But for those who do wish to pick stocks, as it were, the most important thing they can do is to clearly define a circle of competence — that is, to determine what they understand fully and to stay within that circle. And it’s important to note that it’s not so much the size that matters but how well one defines the outer limits. You don’t have to know many things well or do many things right to beat the market.