There are two important reasons why an investor should take asset diversification seriously: One, in the event that something out of the range of normal probabilities occurs. This is something like BP, General Electric, or Wells Fargo. Two, to act as a safeguard against yourself in the event that your analysis might be wrong. Two companies that, even with the benefit of hindsight, would have succeeded in fooling me? Worldcom and Wachovia.
The difficulty in catching Worldcom is that…the company lied. If you curled up and read the annual report, you would have seen numbers reported as assets that were, in fact, liabilities. When the providers of the data lie to you, it’s difficult to mount a successful defense. How perilous is this stuff? When Benjamin Graham was asked in an interview if there were value investing opportunities that he would never pursue, he only came up with one example: Insinuations of bad numbers. If a company was involved in some type of accounting scandal, or if there was a meaningful accusation of an accounting scandal, Graham would stay away altogether because investments can only be justified based on the numbers, and if you have no numbers you can trust, you lose the sound basis for making the investment.