Is Concentration a better strategy than Buy and Hold?

[ICUMD]

@Viking a highly astute and gutsy move!  To be buying only one tech stock as it goes down to a 100% position. Apple of course is an exceptional company and your analysis on point.

 

For unlucky or average folks, results can differ.  When I was younger, I used to take that kind of risk. Nortel went to 0. I was a high school coop student ultimately loosing 20k.  Many of the engineers I knew there lost their retirement savings.

 

While the concentration results can be life altering, my approach today is more modest sticking with a core of banks, rail and utilities.

 

Always found it interesting that Gates had diversified his holdings away from Microsoft and was one of the largest holders of CNR. WB also a rail fan.  Rail is a fantastic example of long term compounding with low risk.

 

 

[thowed]

6 hours ago, Viking said:

All during this time i was probably spending 20 hours a week researching Apple and the industry. Month after month. 

 

Not one size fits all.  The above is an example of when it becomes more reasonable to be very concentrated.  'Watch that Basket' etc. 

 

But for many of us, if you don't have time to research, or don't already know a company inside-out, then it becomes more problematic to be extremely concentrated.

 

And congrats & thanks @Viking your tales are inspirational & helpful.

[Rod]

23 minutes ago, thowed said:

But for many of us, if you don't have time to research, or don't already know a company inside-out, then it becomes more problematic to be extremely concentrated.

But remember if you are very concentrated you have far fewer stocks to research. 

[D33pV4lue]

20 hours ago, D33pV4lue said:

If you held 10 securities in an equally-weighted portfolio worth $1,000. You believe those securities have a 55% chance to double and a 45% chance to go bankrupt in one year. The expected value from investing in the portfolio is $100 or a 10% return. Now if you came across an opportunity that had an 80% chance to double and a 20% chance to go bankrupt how much of your portfolio would you invest in that opportunity?  

 

This is an extreme example but given the investment options, no one should add the new security at the same weight as the other investments. The caveat is that investors regularly overestimate their edge. What they thought was an 80% probability might only be 60% and resulted in more risk than anticipated. 

 

 

https://acquirersmultiple.com/2023/03/charles-munger-theres-nothing-mysterious-about-great-investing/

 

 

[dealraker]

Let me see if I can word this correctly as most of the time I can't.   Somehow let's leave out what Buffett and Munger state, it does go both ways with Buffett, less so with Munger as to concentration.  

 

But my experience is that those with high IQ's and seemingly incredible ability to get the details in order, to get the details right...well my experience is that they do not experience outstanding investment outcome.  I discuss this often and in detail with some local guys who have some serious eggs in the basket.  Basically we say the more intense the investor the more likely the pretense.  We, this local group, tend to also say or state that those that present their stuff the best either in words or writing also have significant problems with successful returns.

 

Almost to a simplistic fault those that are less sure, less of need to present themselves or their expertise...well this is the model of success.  Sometimes it gets crazy, example below.

 

So this guy named Jim, he's close to 90 now, told us in the club for years that his largest holding was GE and in the late 1990's he tried to get the club to buy GE...but we (and some of us had collaborated on our very negative GE report) avoided buying his GE recommendation.  This is the same guy that I wrote about here before on COBF, the guy who got a new computer and had me and my brother-in-law set it up for him- he'd gotten so old he was having trouble logging in on his investment accounts.

 

Jim did inherit some years ago....but damn!  When we set up his computer we saw he had over $50mil in his accounts.  And we also saw he had all kinds of subscriptions to charting sites.  He said, "I buy and never sell...but I do buy using long term charts."

 

Anyway Jim doesn't know what a PE ratio is.  He did run his own shirt mfg plant with 300 workers off and on (he repeatedly tried selling it, but he had to finance it and the buyers always went broke so he got it back), but he always said, "I don't make a school teachers pay running that place."  The building didn't even have a/c in it and that included the "office".

 

But he wasn't the only wealthy guy in my club who could not describe PE ratio...there were many.  The intense guys came and went through the years in our club.  They were generally severe value investors or hyper-tech growth types.  The club was basically a scrambled-egg bunch of guys who moved with the speed of sloth.  We weren't exactly attractive to the intense crowd.  Our investment returns as per the club organization we belonged to were in the top 1% nationwide.

 

I write this simply to remind us that sometimes writing becomes a contest of who can sound the most intelligent at the time.  Whether or not that works out depends on how long the seemingly correct logic of the time holds out to be true.

 

There's not a soul locally anywhere close to my age that doesn't remember Byrd Motor Lines and Glosson Motor Lines both going bankrupt, not once but multiple times.  The story there is of course why I never even think about the small investment I made in Old Dominion Freight Lines decades ago.  This is the "YOU ONLY RENT ENERGY" stocks mandate in full bloom- trucking and oil- boom and bust.  Yet I bought a small amount of Enphase a few years ago and I have quite a few rentals in the energy space that of course will never be rentals because they are fabulous growth stocks.  I own almost no oil stocks; not my game.  But did I know any of this when messing with energy a few years ago.  Hell no, didn't even think about it.  Just kept reading where the energy market cap was historically low to the total market cap.  I think a 5 year old with average intelligence could understand that.

 

Rambling.  But what's the interest rate gunna be and who/what will thrive given high...or low...rates?  Do we really know?  

 

 

 

Edited March 28, 2023 by dealraker

[Saluki]

12 hours ago, Spekulatius said:

Saga partner is a concentrated growth fund that had phenomenal performance in 2020 and subsequently lost it all:

https://www.sagapartners.com/_files/ugd/3b0d6d_ce16f046c4524c08893864f3ce87152c.pdf

 

just one example where one bad year wiped out many years of market beating performance. They stopped making their letter public as well.

 

 

Wow, that was a painful read. Roku, Trupanion, Carvana, GoodRx.  That portfolio looks like it was all offense and no defense. A lot newer managers have never lived through a bear market. 

 

 

[Spekulatius]

20 minutes ago, Saluki said:

 

Wow, that was a painful read. Roku, Trupanion, Carvana, GoodRx.  That portfolio looks like it was all offense and no defense. A lot newer managers have never lived through a bear market. 

 

 

These were all "Zeitgeist" story stocks and then the Zeitgeist shifted.  GDRX was one I tried my luck with a small starter position, but after a grocery partner left (later came back) it was an indication to me that the moat wasn't as strong as perceived. Then there also was a shift to free to use to a subscription model, which to me seemed to have questionable customer appeal.

 

Anyways, I sold this with a 15% or thereabout loss and never looked back. These guys held on to losing bets much longer.

[scorpioncapital]

I almost went bankrupt once investing concentrated in a black box. I vowed to myself I will never ever invest in a black box. The company has to do 1 thing I can keep my eye on. And if it is a conglomerate it better have a leader I can really keep my eye on it, and even then their strategy should not be too complex.  This is why I now find investing in banks, investment managers, insurance cos (except maybe Berkshire) is not for me. Too much black box.

Edited March 28, 2023 by scorpioncapital

[dealraker]

9 minutes ago, scorpioncapital said:

I almost went bankrupt once investing concentrated in a black box. I vowed to myself I will never ever invest in a black box. The company has to do 1 thing I can keep my eye on. And if it is a conglomerate it better have a leader I can really keep my eye on it, and even then their strategy should not be too complex.  This is why I now find investing in banks, investment managers, insurance cos (except maybe Berkshire) is not for me. Too much black box.

Bank investments are a good way to get intermittently reminded not to do this type investing.  You wake up to 20% stock price drops and swear it off for years...until you (or me in this case) do it all over again.

 

Less than 3.5% in banks and wonder what the hell got me there.  Seriously LOL!   

 

 

[Gregmal]

I am agnostic to and even embrace volatility or hard to value stuff, but I avoid like the plague things where fundamentals can change overnight. Banks seem to fall into that category. 

[KCLarkin]

4 hours ago, Saluki said:

 

Wow, that was a painful read. Roku, Trupanion, Carvana, GoodRx.  That portfolio looks like it was all offense and no defense. A lot newer managers have never lived through a bear market. 

 

 

I follow Joe on Twitter and have a very favourable opinion of him.

 

But this is a good example of why "diversification" doesn't save you. He owned 7 companies, which is plenty enough to build a diversified portfolio. But they were all highly correlated. You can imagine similar results if he had a 20 or 30 company portfolio. I saw this in plenty of portfolios after Covid. If you have 20 tech stocks or 20 commodity stocks or 20 weed stocks or 20 financials or 20 tokens or or 20 growth stocks or 20 cigar butts, you aren't diversified.

 

But with a little imagination you can make a diversified portfolio with just 3 or 4 stocks.

 

[ICUMD]

56 minutes ago, dealraker said:

Bank investments are a good way to get intermittently reminded not to do this type investing.  You wake up to 20% stock price drops and swear it off for years...until you (or me in this case) do it all over again.

 

Less than 3.5% in banks and wonder what the hell got me there.  Seriously LOL!   

 

 

@dealraker Can't think of a company doesn't have a 20% drop from time to time. Tech are far worse - they get wiped out. CDN banks have an exceptional track record.

[Spekulatius]

35 minutes ago, KCLarkin said:

I follow Joe on Twitter and have a very favourable opinion of him.

 

But this is a good example of why "diversification" doesn't save you. He owned 7 companies, which is plenty enough to build a diversified portfolio. But they were all highly correlated. You can imagine similar results if he had a 20 or 30 company portfolio. I saw this in plenty of portfolios after Covid. If you have 20 tech stocks or 20 commodity stocks or 20 weed stocks or 20 financials or 20 tokens or or 20 growth stocks or 20 cigar butts, you aren't diversified.

 

But with a little imagination you can make a diversified portfolio with just 3 or 4 stocks.

 

I would argue that 20 stocks in the same "Zeitgeist" bucket is not really diversification. this is essentially what happened with the Motley Fool portfolios. MF recommend 20 holding at least stocks, but all the 20 stocks they recommended in 2020/21 were very similar (unprofitable and speculative growth) and tanked the same way. This is not diversification, this was a highly correlated bet. Saga did the same thing they had 7 stocks, but it was basically one highly correlated bet.

 

If you go with let's say  20 stocks you should make sure they represent different sectors of the economy and may even different geographical areas / countries. All stocks being in China in my opinion is very very risky for example.

[dealraker]

19 minutes ago, ICUMD said:

@dealraker Can't think of a company doesn't have a 20% drop from time to time. Tech are far worse - they get wiped out. CDN banks have an exceptional track record.

Said tongue-in-cheek style ICUMD, the words are not meant to be interpreted literally - what scorpion was alluding to and I facetiously promoted was that there's nothing within bank investing that has words available to describe the lack of knowing when the crap hits the fan.  I've been a bank investor since 1975 and it gets exciting in new new ways all the time.  

[Spekulatius]

3 minutes ago, dealraker said:

Said tongue-in-cheek style ICUMD, the words are not meant to be interpreted literally - what scorpion was alluding to and I facetiously promoted was that there's nothing within bank investing that has words available to describe the lack of knowing when the crap hits the fan.  I've been a bank investor since 1975 and it gets exciting in new new ways all the time.  

Drops can happen with anything. I remember when SHEL (then Royal Dutch) "lost" more than 20% of their proved reserves in one day in 2004. the stock tanked big time and had a hard time to recover. SHEL had goosed their reserve numbers for years at it turnout out.

https://www.sec.gov/news/press/2004-116.htm

 

This happened to the second largest oil and gas companies in the world.

[dealraker]

16 minutes ago, Spekulatius said:

Drops can happen with anything. I remember when SHEL (then Royal Dutch) "lost" more than 20% of their proved reserves in one day in 2004. the stock tanked big time and had a hard time to recover. SHEL had goosed their reserve numbers for years at it turnout out.

https://www.sec.gov/news/press/2004-116.htm

 

This happened to the second largest oil and gas companies in the world.

Yea when the reserves disappear we are heading towards my theme with banks.  Better that, those one day smash downs, than the GE thing.  I am so glad Munger finally stepped up to say something accurate about Jack Welch is his Combs interview.  

[valueseek]

9 hours ago, dealraker said:

Let me see if I can word this correctly as most of the time I can't.   Somehow let's leave out what Buffett and Munger state, it does go both ways with Buffett, less so with Munger as to concentration.  

 

But my experience is that those with high IQ's and seemingly incredible ability to get the details in order, to get the details right...well my experience is that they do not experience outstanding investment outcome.  I discuss this often and in detail with some local guys who have some serious eggs in the basket.  Basically we say the more intense the investor the more likely the pretense.  We, this local group, tend to also say or state that those that present their stuff the best either in words or writing also have significant problems with successful returns.

 

Almost to a simplistic fault those that are less sure, less of need to present themselves or their expertise...well this is the model of success.  Sometimes it gets crazy, example below.

 

So this guy named Jim, he's close to 90 now, told us in the club for years that his largest holding was GE and in the late 1990's he tried to get the club to buy GE...but we (and some of us had collaborated on our very negative GE report) avoided buying his GE recommendation.  This is the same guy that I wrote about here before on COBF, the guy who got a new computer and had me and my brother-in-law set it up for him- he'd gotten so old he was having trouble logging in on his investment accounts.

 

Jim did inherit some years ago....but damn!  When we set up his computer we saw he had over $50mil in his accounts.  And we also saw he had all kinds of subscriptions to charting sites.  He said, "I buy and never sell...but I do buy using long term charts."

 

Anyway Jim doesn't know what a PE ratio is.  He did run his own shirt mfg plant with 300 workers off and on (he repeatedly tried selling it, but he had to finance it and the buyers always went broke so he got it back), but he always said, "I don't make a school teachers pay running that place."  The building didn't even have a/c in it and that included the "office".

 

But he wasn't the only wealthy guy in my club who could not describe PE ratio...there were many.  The intense guys came and went through the years in our club.  They were generally severe value investors or hyper-tech growth types.  The club was basically a scrambled-egg bunch of guys who moved with the speed of sloth.  We weren't exactly attractive to the intense crowd.  Our investment returns as per the club organization we belonged to were in the top 1% nationwide.

 

I write this simply to remind us that sometimes writing becomes a contest of who can sound the most intelligent at the time.  Whether or not that works out depends on how long the seemingly correct logic of the time holds out to be true.

 

There's not a soul locally anywhere close to my age that doesn't remember Byrd Motor Lines and Glosson Motor Lines both going bankrupt, not once but multiple times.  The story there is of course why I never even think about the small investment I made in Old Dominion Freight Lines decades ago.  This is the "YOU ONLY RENT ENERGY" stocks mandate in full bloom- trucking and oil- boom and bust.  Yet I bought a small amount of Enphase a few years ago and I have quite a few rentals in the energy space that of course will never be rentals because they are fabulous growth stocks.  I own almost no oil stocks; not my game.  But did I know any of this when messing with energy a few years ago.  Hell no, didn't even think about it.  Just kept reading where the energy market cap was historically low to the total market cap.  I think a 5 year old with average intelligence could understand that.

 

Rambling.  But what's the interest rate gunna be and who/what will thrive given high...or low...rates?  Do we really know?  

 

 

 

Tks for some excellent posts. Esp. The art of writing vs investing long term

[mattee2264]

I think where Berkshire excel is that they make big bets where the downside risk is low and the upside potential is above average returns for many years. They are also very good at adding to positions over time as their conviction grows.

 

It is true that people become multi-millionaires by concentrating most of their funds in a small business of which they are the owner-managers. But it is also true that a lot of people put blood, sweat, time and money into their business and either it fails or returns are pretty mediocre. I would also dispute that a passive investor can get the same kind of results by identifying such businesses poised to succeed especially as they lack the inside knowledge/industry expertise/management control etc. Also small cap growth is a treacherous field to invest in and it is easy to be deceived by fast growth rates that rarely last and they often tend to be overvalued and when they do hit a bump in the road and get cheap they don't have the same resources that big companies have to pull through and emerge stronger. 

 

And worth noting that a lot of Berkshire's success is identifying mature growth companies that still have a long growth runway and an enduring competitive advantage. But again that is a difficult judgement to make and the risk is you misjudge things and the next stage of the company life cycle is decline which will mean little further growth or even negative growth and declining PE ratios and incredibly disappointing returns that are amplified by concentration.

 

I guess the point I am making is that it isn't as easy as it looks. 

 

The good thing is that even owning 15-20 stocks is a sufficient level of concentration to give you a real chance of beating the market by a good margin over time if you are a patient and disciplined and most of all competent investor. And some concentration will develop as a consequence of letting winners ride and cutting losses when something is clearly not working out. But this is very different from saying that you should start with 30-40% positions from the outset. Rather you start with say 5-10%. And you might over a period of years build up the cost basis to approaching 20%. But on a cost basis in most instances even if you make a really bad mistake (and even the best investors do) it won't destroy your results. 

 

Also something I think is a great compromise for most investors is a core and explore type approach. Your default strategy is to be invested in a global diversified index fund. Say 70-80%. And then with that diversification underpinning your profile you can make some moderately big bets on a handful of stocks where you feel the odds are stacked in your favour and you are well within your circle of competence.

 

I also agree with the simple thesis idea. It shouldn't require a 100 page power point presentation and an excel model encompassing hundreds of tabs to make a good investment. I think for most of the no-brainers or relatively sure things that most individual investors should be looking to invest in a back-of-the envelope calculation supported by a good understanding of the qualitative factors gleaned from reading annual reports/financial news/trade journals/cloning etc and a relatively basic financial analysis of trends in KPIs and financial condition etc should suffice. And if that analysis does not result in relative confidence or is too difficult to put together then probably the idea is too complicated or dependent on too many moving parts or outside your circle of competence etc. 

 

 

 

[Paarslaars]

BRK lost 25% of its market cap in less than 3 months last year, it happens to the best of them.  

[dealraker]

Again, drops in price that result in realizing you don't know what the asset is worth are different than "everything drops 20-25%" from time to time.  Buffett himself found that out in Irish-land.  

Edited March 29, 2023 by dealraker

[Spekulatius]

55 minutes ago, dealraker said:

Again, drops in price that result in realizing you don't know what the asset is worth are different than "everything drops 20-25%" from time to time.  Buffett himself found that out in Irish-land.  

He lost all his money on Irish banks, but this was a tiny bet. His biggest bets are all based on downside protection much more so than on perceived upside. He was also wrong on IBM, but lost not a lot of money there, as a percentage of his investment - the bigger loss was time value of money.

 

Maybe that's the thing that allows concentration, at least for me in the few times, i took a large position it was mainly because I saw very little chance of a permanent impairment.

[SharperDingaan]

The reality is that if you are going to concentrate; you have to have the risk tolerance, temperament, runway, technical expertise, inside knowledge, circle of competence, etc. to back it. If you are just going to be a tourist, with little more than a wad of money, it is very likely not going to go well. Instantly eliminates 80%+ of people.

 

Always the business approach; execution up to you. Own a business and your (hopefully) annual profit is your return, it is a lot of constant work, and maybe you exit at 1-2x 3-yr average EBITDA - if  you can find a buyer willing to pay up. Own stock, and exit is just a button push. The business approach is refreshing, but to really make it work you need partners over which to split the risk/workload; more marriages!

 

A great business is just one with a strong franchise; if it has strong management it does very well, if it has sh1te it still makes a profit. To avoid unduly relying on management, pick commodities franchises; quarterly earnings primarily the result of underlying commodity prices, not management (baring black swan actions).

 

If your investment objective is simply inflation plus 1-3%; for most people, simple indexing will be more than adequate. But if your objective is something better, you need to change your approach. The good news is that there are many approaches, as posters on COBF prove every day.

 

Good luck.

 

SD 

 

 

Edited March 29, 2023 by SharperDingaan

[Castanza]

On 3/28/2023 at 3:24 PM, Gregmal said:

I am agnostic to and even embrace volatility or hard to value stuff, but I avoid like the plague things where fundamentals can change overnight. Banks seem to fall into that category. 

 

Yup, banks always seem like a black box. I mean just look how nobody except a few individuals were talking about this HTM stuff until it blew up. Others had to know but chose to ignore it. Better to trade than hold imo. 

[LC]

If you think the banks HTM book is a mess, wait till you look at the government.

 

I don't think banks are such a black box. Yes, there is the question of loan quality through the cycle. But I think investors have decent insight into the loan book between all the resources available. 

 

Banks holding 2.xx% mortgages is really a nothing burger for the big boys. The Feds hold way more. So they are all in the same boat. And the Feds control policy. 

 

Another way to think of it: the entire world had 10 years of ZIRP to "disrupt" the banks: ultimately ended in failure for the incumbents. That's the sign of a decent business if you ask me. 

[sleepydragon]

black box shouldn't mean it shall be avoided. In fact, that means they are "un-investable" for many and thus should have more alphas to exploit.  For example, in early days of google, it looks like a blackbox too. nobody understand how google is making money..  Besides, for banks, they are not completely black box. They are just harder to understand for most people. But I think Buffett got it this time, and he sold all those bank stocks.