Toyota: Another Lesson in Concentration Risk

Toyota Motor Corporation has been one of the most respected automakers in the world. It is widely admired for making high-quality cars, and for being a profitable operation, while its American counterparts for the most part have run themselves into the ground. If you were going to own stock in an automaker, this likely would have been high on the list of candidates.

But the recent recall of millions of its cars due to serious safety concerns has rather suddenly hung a dark cloud over the company. As James Stewart points out in his Wall Street Journal article, it’s not just current profits that are at risk - the company’s reputation is on the line as well. Sales have already been adversely impacted and there is speculation that the company’s woes have not been completely revealed at this point. As of this writing, Toyota stock has lost nearly 25% of its value in not much more than a week. Toyota is not going out of business, but its shareholders certainly have cause to be nervous.

This episode is a great reminder of the importance of diversification and avoiding the needless risk of being concentrated in a single stock. No matter how “safe” an individual stock seems - because of the nature of its industry, its management, or how well the investor thinks he knows the company - there is always the risk of a negative event that can severely or mortally wound a company. And they often appear to be doing just fine right before it happens.