Concentration

[Guest hellsten]

Geoff Gannon on Warren Buffett and concentration:

http://www.gurufocus.com/news/169950/how-warren-buffett-made-his-first-100000

 

Here’s Warren Buffett from The Snowball:

 

“Ben would always tell me GEICO was too high. By his standards, it wasn’t the right kind of stock to buy. Still, by the end of 1951, I had three-quarters of my net worth or close to it invested in GEICO.”

 

Buffett worshipped Graham. But it didn’t matter. He went ahead and broke two of Graham’s rules:

 

1. GEICO wasn’t selling for a Ben Graham price

 

2. Ben Graham would never put 75% of his portfolio into one stock

 

Why did Buffett do this?

 

Because Buffett wanted to get rich. He didn’t want to fill his portfolio with 1 great idea (GEICO) and 4 good ideas and then only have 20% of his money in GEICO.

 

If GEICO rose 50% next year when Buffett had 75% of his portfolio in GEICO he would grow his capital 37.5% just from GEICO’s contribution. If he spread his portfolio evenly over 5 stocks, then a 50% rise in GEICO’s price next year would only increase his capital by 10%.

 

Buffett wasn’t interested in compounding his money at 10%. He was interested in compounding his money at 30% or 40%. He wasn’t going to buy something in a way that each idea would contribute that little.

 

From the very beginning of his career, Buffett always felt safer in his best idea (that would compound his money the fastest) rather than spread out over half a dozen slightly lesser ideas.

 

He would repeat this GEICO pattern over and over again. While Buffett rarely put 75% of his money in one idea – he did try to buy as many shares as possible of his best idea at several points in his first few years investing.

 

He also borrowed money. Buffett had too many ideas and too little capital. So, he actually got his Dad to cosign a loan for him so he could put more money into his best ideas.

 

These are things Ben Graham would not have done. Now, Graham did use margin early in his career – everyone did back then. And Graham would borrow against arbitrage positions in the fund. But that’s not what we’re talking about here. Buffett took out a loan from a bank so he could add to the total investment capital he had.

 

 

[sethatk]

 

 

For all the moat investors on the board there are some really nice, relatively cheap growth stocks at this level as well. It's a lot easier for a $50m company to go up 100x than it is for a $5b company.

 

Any ideas? :)

SPRO, SmartPros I have been buying it for close to cash on hand. Book value per share is about 2.30. Negatives-high compensation for CEO and burn rate. They plan to grow by aqcusition. However, the CEO owns 15% and other insiders own 10%. With an approved share buyback of 750,000.

[Palantir]

I appreciate the idea, but where do you see that you bought it for cash? Google says they have 2M in cash for a 20M cap firm.

 

Oddball has inspired me to find growth stocks in the sub 100M space. One I found, unfortunately already has had a huge runup, but it is a moat/growth firm, so there could be plenty of upside in the future if op results are good....I will post it after I initiate a position.

[sethatk]

http://finance.yahoo.com/news/smartpros-reports-third-quarter-2012-211054943.html

 

Here is their latest results.

 

[Palantir]

http://finance.yahoo.com/news/smartpros-reports-third-quarter-2012-211054943.html

 

Here is their latest results.

 

Ok fair enough, I must have been looking at the wrong ticker. That being said....where do you see growth here?

[sethatk]

The CEO has stated the primary goal is to make acquisitions. There core is accounting and legal. If they can get any other areas going would help. They also have zero debt.

[Guest hellsten]

Warren on concentration (quoting Billy Rose):

"You've got a harem of seventy girls; you don't get to know any of them very well"

 

Taken from the 1965 partnership letter:

http://www.rbcpa.com/WEB_letters/1966.01.20.pdf

 

We diversify substantially less than most investment operations. We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could drastically change underlying value of the investment.

 

Two securities could have equal mathematical expectations, but one might have .05 chance of performing fifteen percentage points or more worse than the Dow, and the second might have only .01 chance of such performance. The wider range of expectation in the

first case reduces the desirability of heavy concentration in it.

 

Not related to concentration, but still interesting is the part where Warren talks about groupthink:

Group decisions – my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions

 

Here's a video of an interesting study of groupthink in disasters:

 

Not even a fire alarm or seeing smoke is enough to break out of groupthink.

[Kraven]

Warren on concentration (quoting Billy Rose):

"You've got a harem of seventy girls; you don't get to know any of them very well"

 

Really?  The argument against diversification is that having too many stocks is like having too many women because its such a negative?  Given Buffett's proclivities I doubt he really believes that. Perhaps a better analogy is in order.

[constructive]

Warren on concentration (quoting Billy Rose):

"You've got a harem of seventy girls; you don't get to know any of them very well"

 

Really?  The argument against diversification is that having too many stocks is like having too many women because its such a negative?  Given Buffett's proclivities I doubt he really believes that. Perhaps a better analogy is in order.

 

I imagine that by age 82, the attractions of a 70 woman harem have faded quite a bit.

[GrizzlyRock]

Hey guys here is my take on optimal portfolio allocation: http://www.marketfolly.com/2013/01/position-sizing-utilizing-kelly-growth.html

 

Klarman's comments as posted in this thread basically say the same thing without getting into the Kelly formula. (Not that I am holding myself to be as astute as Klarman!)

[siddharth18]

Warren on concentration (quoting Billy Rose):

"You've got a harem of seventy girls; you don't get to know any of them very well"

 

Taken from the 1965 partnership letter:

http://www.rbcpa.com/WEB_letters/1966.01.20.pdf

 

rbcpa.com is one heck of a website. Especially their "Investment Management" section http://www.rbcpa.com/invindex.html. Thanks for posting!

[Guest hellsten]

Charlie Munger on how to beat the system:

 

The model I like—to sort of simplify the notion of what goes on in a market for common stocks—is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what's bet. That's what happens in the stock market.

…

And the one thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom.

 

It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it—who look and sift the world for a mispriced be—that they can occasionally find one.

 

And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

 

That is a very simple concept. And to me it’s obviously right—based on experience not only from the pari-mutuel system, but everywhere else.

 

And yet, in investment management, practically nobody operates that way. We operate that way—I’m talking about Buffett and Munger. And we’re not alone in the world. But a huge majority of people have some other crazy construct in their heads. And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they’ll come to know everything about everything all the time.

 

http://ycombinator.com/munger.html

[PlanMaestro]

Pmjar interviews Howard Marks: Concentration vs Diversification.

 

"Concentration is better if you have superior insight, and diversification is better if you have limited insight."

 

http://www.pmjar.com/?p=1554

[Packer16]

I also find interesting his comment on diversification versus "cheapness" as tools of risk reduction.  He ranks cheapness fisrt and then diversification if enough cheap stocks can be found.  He also states the lesson of 2008 is not to have a portfolio that can withstand a 2008-type event. 

 

Packer

[Potato]

Perhaps not the best topic to de-lurk on, but my approach is a touch different as I also diversify between portfolios: I have a passive/index portfolio to meet my minimum needs in case I am fooling myself about my investing abilities and I am one of the unwashed masses better off not picking their own stocks. Then within my active portfolio I have a few names that make up the bulk of it, around 10% each, and a number of more speculative/less understood positions of 1-2% each, with at any time 15-25 stocks.

 

I've made far too many mistakes in my short investing career to have the confidence to put more than 20% in one name, and only rarely even that much. Any time I read great reasons for more concentration (like "why focus on your 10th best idea?") I remember to balance it with the First Rule, recalling times when I've missed something, made a mistake, or something completely unexpected happened.

 

Anyway, this is what I felt the need to comment on:

 

  In any case here is a much simple experiment. The guys at gurufocus have created a portfolio which gathers the most weighted holdings of "gurus", most of which are value investors. These guys obviously haven't made their names by being closet trackers, so in first approximation we can forget about tilts and the like and just look at the straight results:

 

http://www.gurufocus.com/model_portfolio.php?mp=hr_largecap

 

You see many names discussed here in the list. But there is barely any outperformance since 2006. Perhaps if you have several decades of data, track things more often, etc. you will see something. But it does not scream at you.

 

This reminds me of a story* about a hospital's charitable foundation. They hired a board of 5 investment managers, each of who was successful in their own right. They only bought stocks for the foundation which they could all agree on. Over the next year each of the 5 investors had great individual success, but the foundation, representing their consensus picks, had underwhelming performance. The moral was that it was very difficult to have both consensus and value.

 

I've always wanted to test that anecdote by looking at the picks of a group of investors, and where there was and was not overlap, but I haven't had the raw data or time.

 

* - I'm sorry I don't have the source. I believe it was from one of the lectures at Ivey/Ben Graham School but I've been trying to find it again for a few years and haven't managed to dig up the link to the specific video. If one of you is familiar with it and knows the source I'd love to have it!

[james22]

Scientists have been doing something similar to Kaizen for centuries. Once in a while people come up with a wonderful idea and you get a new theory straight away, but more often great advances are obtained by incremental, continuous improvements during decades, like the last two Nobel Prizes in Cosmology.

 

Actually, Thomas Kuhn (1922-1996) argued that scientific advancement is not evolutionary, but rather is a "series of peaceful interludes punctuated by intellectually violent revolutions", and in those revolutions "one conceptual world view is replaced by another".

 

http://www.amazon.com/The-Structure-Scientific-Revolutions-Edition/dp/0226458083

 

I'm open to swapping my BRK and BRK-like individual stocks for a (single) index fund leveraging Small/Value/Momentum/Quality factors if it proves superior.