Absolute Investment Targets

[racemize]

In light of Pabrai's Columbia videos, I've been thinking about absolute return targets.  His minimum requirement is expectation of 2-3x in 2-3 years, or 26% per annum.  Personally, I've been using 10% with a 20% margin of safety requirement (so expecting at least 12% per annum), but focusing on those ideas with the highest upside, or having a long enough record.  This has resulted in me having "compounders" in one portion of the portfolio (e.g., BRK, MKL, FFH, LUK), which, if bought at the right prices should have a long term return of more than 10%, but likely less than 20%, and then a second portion having much higher upside--so far the second portion has done better, but the compounders are there for safety and reliability.

 

I guess, said another way, I have a 12% target rather than a 26% target, but then scale up rapidly from that target.  In light of Pabrai's comments, I'm considering changing the target, but that moves me out of my favorite compounders, which makes me feel a little uneasy (and slightly sad). 

 

How does everyone else think about this?

[hyten1]

well  i typically look for things that i can see it double within 1 to 3 years, that is my hurdle rate

 

 

hy

[petec]

I think it depends on how much time you're going to invest.  I have most of my money in high quality stocks where I think the long term return (FCF yield + 3% inflation + real growth) is likely to be >10%.  I broadly regard that portfolio as having very low operational risk but also as not being particularly undervalued, so I do try to hedge out tail risks that would severely affect valuations of very high quality operations.  If I wanted to dedicate more time, I would edge towards undervalued situations with 2-3x in 2-3y potential, but I don't because my current focus needs to be on the day job!

 

I do keep a cash pot aside for the occasional just-too-cheap stock though :)  It's what makes investing fun.

[CONeal]

well  i typically look for things that i can see it double within 1 to 3 years, that is my hurdle rate

 

 

hy

 

My target is the expectation of 30% per year wheither it be in undervalued stocks or the savings on prepaid haircuts  :D

[jberkshire01]

Seth Klarman's thoughts:

 

[HBS] Do you set an annual return target?

 

[Klarman] We think it’s madness to target a return. Return lies in some relationship to risk, albeit there are moments when it’s out of whack, when you can make a high return with very limited risk. My view is that you can target risk versus return. So you can say, I’ll take the very safe 6 percent, I’ll take the somewhat risky 12, or I’ll take the enormously risky 20, knowing that 20 might actually be minus 20 by the time the actual results are known. We just don’t think targeting a return is smart.

 

http://www.alumni.hbs.edu/bulletin/2008/december/oneonone.html

 

[giofranchi]

In light of Pabrai's Columbia videos, I've been thinking about absolute return targets.  His minimum requirement is expectation of 2-3x in 2-3 years, or 26% per annum.  Personally, I've been using 10% with a 20% margin of safety requirement (so expecting at least 12% per annum), but focusing on those ideas with the highest upside, or having a long enough record.  This has resulted in me having "compounders" in one portion of the portfolio (e.g., BRK, MKL, FFH, LUK), which, if bought at the right prices should have a long term return of more than 10%, but likely less than 20%, and then a second portion having much higher upside--so far the second portion has done better, but the compounders are there for safety and reliability.

 

I guess, said another way, I have a 12% target rather than a 26% target, but then scale up rapidly from that target.  In light of Pabrai's comments, I'm considering changing the target, but that moves me out of my favorite compounders, which makes me feel a little uneasy (and slightly sad). 

 

How does everyone else think about this?

 

Hi racemize,

ok, that’s how I see it:

I started some years ago with a capital of $1 million. My goal was to increase capital 15% each year for 50 years. To achieve that goal, I rely both on the operating earnings of the businesses my firm controls, and on the results of my favorite businesses which my firm possesses little pieces of. That way, by the time I retire, I would be a billionaire. And throughout my whole career I would have earned on average $1.6666667 million each month! If you could find a reliable way to achieve that result, why stray far from the sure formula?! Aren’t you satisfied with $1.6 million a month?! Won’t it be proof enough that you really have done things intelligently, and you really have succeeded in creating wealth over time? The surest formula I know of is to partner with outstanding capital allocators, and to constantly keep generating the cash that enables you to double down on them, when the market gives you the chance to do that.

Like Kraven is used to saying “you don’t know, what you cannot know”. So, be aware of the “man at the helm” risk, as I like to put it. And spread your bets among 10 to 15 compounders. Otherwise, I really don’t see how you can fail to achieve your “$1.6 million a month” and “billionaire at the end” status!  ;)

PS

Until now I have increased capital at a 17% annual rate… so far so good!  ;D

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. One’s knowledge and experience is definitely limited and there are seldom more than two or three enterprises at any given time which I personally feel myself entitled to put full confidence.” - John Maynard Keynes

[premfan]

In light of Pabrai's Columbia videos, I've been thinking about absolute return targets.  His minimum requirement is expectation of 2-3x in 2-3 years, or 26% per annum.  Personally, I've been using 10% with a 20% margin of safety requirement (so expecting at least 12% per annum), but focusing on those ideas with the highest upside, or having a long enough record.  This has resulted in me having "compounders" in one portion of the portfolio (e.g., BRK, MKL, FFH, LUK), which, if bought at the right prices should have a long term return of more than 10%, but likely less than 20%, and then a second portion having much higher upside--so far the second portion has done better, but the compounders are there for safety and reliability.

 

I guess, said another way, I have a 12% target rather than a 26% target, but then scale up rapidly from that target.  In light of Pabrai's comments, I'm considering changing the target, but that moves me out of my favorite compounders, which makes me feel a little uneasy (and slightly sad). 

 

How does everyone else think about this?

 

Hi racemize,

ok, that’s how I see it:

I started some years ago with a capital of $1 million. My goal was to increase capital 15% each year for 50 years. To achieve that goal, I rely both on the operating earnings of the businesses my firm controls, and on the results of my favorite businesses which my firm possesses little pieces of. That way, by the time I retire, I would be a billionaire. And throughout my whole career I would have earned on average $1.6666667 million each month! If you could find a reliable way to achieve that result, why stray far from the sure formula?! Aren’t you satisfied with $1.6 million a month?! Won’t it be proof enough that you really have done things intelligently, and you really have succeeded in creating wealth over time? The surest formula I know of is to partner with outstanding capital allocators, and to constantly generating the cash that enables you to double down on them, when the market gives you the chance to do that.

Like Kraven is used to saying “you don’t know, what you cannot know”. So, be aware of the “man at the helm” risk, as I like to put it. And spread your bets among 10 to 15 compounders. Otherwise, I really don’t see how you can fail to achieve your “$1.6 million a month” and “billionaire at the end” status!  ;)

PS

Until now I have increased capital at a 17% annual rate… so far so good!  ;D

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. One’s knowledge and experience is definitely limited and there are seldom more than two or three enterprises at any given time which I personally feel myself entitled to put full confidence.” - John Maynard Keynes

 

Very nice on the 17 percent annually. When did you start investing?

[giofranchi]

Very nice on the 17 percent annually. When did you start investing?

 

My firm got incorporated in 2004, and I started investing its fcf in 2006.  :)

 

giofranchi

 

“As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. One’s knowledge and experience is definitely limited and there are seldom more than two or three enterprises at any given time which I personally feel myself entitled to put full confidence.” - John Maynard Keynes

[biaggio]

FWIW, I like those compounders as well. My investment style has continued to evolve, hopefully to the better thanks to all the thoughtful posters here.

 

I set target or hurdle rate when purchasing.. Example, if you are looking  to buy LUK but want to make 2 x your money in 3 years then you would try to buy at 50% of what you think it's worth. Ideally, especially in taxable account  I like to hold it longer if possible. As a consequence have had a fair amount of round trips, usually because of poor selection, wrong company ie not a true compounder, or wrong price.

 

I have a small part of portfolio for more speculative buys as well

 

Agree with gio  as a working person and mere mortal I would be ecstatic to have 12-15% compounded over the next 50 years.i also believe partnering with the right people is the way to go

 

Race,I think having a target of 12%, probably realistic but might be too low. Makes sense to aim for 20-25%. Aim for the stars you might hit the moon and  still be happy

[mranski]

Regarding  owner operators (compounders) and portfolio concentration, I think WEB has clearly embraced the portfolio concentration, but i'm not sure about the owner operator. He still seems to embrace non owner operators . i.e. BNI, IBM, WFC, Lubrizol. 

[jay21]

Regarding  owner operators (compounders) and portfolio concentration, I think WEB has clearly embraced the portfolio concentration, but i'm not sure about the owner operator. He still seems to embrace non owner operators . i.e. BNI, IBM, WFC, Lubrizol.

 

Reading Snowball made me realize how much contact Buffet has with executives.  He knows the people extremely well.  I think he also said that he has a better track record with hiring managers than investing.  So I am not too worried about the executives he brings into his company through stock purchases and acquisitions.

 

He does have owner operators to some extent in Marmon, MidAmerican, Iscar, WMT, etc.

[twacowfca]

Regarding  owner operators (compounders) and portfolio concentration, I think WEB has clearly embraced the portfolio concentration, but i'm not sure about the owner operator. He still seems to embrace non owner operators . i.e. BNI, IBM, WFC, Lubrizol.

 

 

Those companies have been around for 100+ years and have demonstrated staying power and pricing power or low cost advantage with favorable prospects as far as the eye can see.  :)

[racemize]

Based on this thread (thanks everyone!), some thought, and Pabrai's presentation, I've come up with this for myself:

 

1st 50% of cash - minimum of 2x in 5 years (15% annual growth, e.g., compounders)

next 20% - minimum of 2x in 3-4 years (20% annual growth)

next 10% - minimum of 2x in 2-3 years (25% annual growth)

next 5% - minimum of 3x in 2-3 years (45% annual growth)

next 5% - minimum of 4x in 2-3 years (60% annual growth)

next 5% - minimum of 5x in 2-3 years (70% annual growth)

last 5% - more than 5x in 2-3 years (>70% annual growth)

 

This should help solidify my thinking and keeping me from being too fully invested at times (e.g., now).

[Kraven]

Based on this thread (thanks everyone!), some thought, and Pabrai's presentation, I've come up with this for myself:

 

1st 50% of cash - minimum of 2x in 5 years (15% annual growth, e.g., compounders)

next 20% - minimum of 2x in 3-4 years (20% annual growth)

next 10% - minimum of 2x in 2-3 years (25% annual growth)

next 5% - minimum of 3x in 2-3 years (45% annual growth)

next 5% - minimum of 4x in 2-3 years (60% annual growth)

next 5% - minimum of 5x in 2-3 years (70% annual growth)

last 5% - more than 5x in 2-3 years (>70% annual growth)

 

This should help solidify my thinking and keeping me from being too fully invested at times (e.g., now).

 

I honestly have no clue about things like this and would have no idea how to even begin to categorize investments in this manner. Perhaps I am missing something obvious. What are some examples of things that would be in some of these categories, particularly the latter ones? 

[Palantir]

I value investments conservatively so they return at least 10%. If the stock's business performance continues the way it has, in theory, it'll vastly outstrip 10%.

[racemize]

Based on this thread (thanks everyone!), some thought, and Pabrai's presentation, I've come up with this for myself:

 

1st 50% of cash - minimum of 2x in 5 years (15% annual growth, e.g., compounders)

next 20% - minimum of 2x in 3-4 years (20% annual growth)

next 10% - minimum of 2x in 2-3 years (25% annual growth)

next 5% - minimum of 3x in 2-3 years (45% annual growth)

next 5% - minimum of 4x in 2-3 years (60% annual growth)

next 5% - minimum of 5x in 2-3 years (70% annual growth)

last 5% - more than 5x in 2-3 years (>70% annual growth)

 

This should help solidify my thinking and keeping me from being too fully invested at times (e.g., now).

 

I honestly have no clue about things like this and would have no idea how to even begin to categorize investments in this manner. Perhaps I am missing something obvious. What are some examples of things that would be in some of these categories, particularly the latter ones?

 

I hadn't really thought about things this way until I saw Pabrai's video either.  What I had noticed is that when I was investing, I treated the first 50% fairly similar to the last 10%, which I realized was probably not correct.  Said another way, the money should become more and more dear until you are only willing to invest the last 5 or 10% if we are truly at a crazy market low (e.g., 2008 or near-abouts) in order to have money at the opportune time.  This seems to make sense to me, as otherwise you are unlikely to have cash at the right time, without having some macro forecasting going on.

 

For him, he would not consider investing unless it was a double in 2-3 years, and the latter categories are copies of his.  I modified it to fit more in line with my thinking.  Here's my thinking for each category section (and again, I'm trying to modify how I'd been approaching it, so this is still somewhat squishy and changing in my mind):

 

Category 1: I think reasonable expectations of 15% annual returns in investments is the lowest I'm willing to sign up for--or said another way, 10% with a large margin of safety.  Examples here might be FFH/MKL/BRK/LUK ~book value.  Other investments over shorter periods also make some sense in this category, perhaps moderately undervalued moat companies that you expect mean reversion over time (maybe WFC at P/E of 8 with expectations of acceptable growth). 

 

Categories 2 and 3: We've moved up in the chain, so this will probably be shorter term and not buy and hold as much (e.g., strong mean reversion).  Or perhaps, when they mean revert, we end up with category 1 companies if we held them.  Examples may be something like AIG/BAC at the current prices.

 

Category 4: BAC at 7 perhaps?

Category 5: BAC at 5 perhaps?

Categories 6 and 7: Various good companies at the bottom of 2008?

[ASTA]

I think this makes a lot of sense as the time to make the most money is when times are very bad. Think Munger and Warren's personal investment of treasurer's for 6 years at least early 2000's.

So my personal portfolio is 20% FFH 20% brk.b and some financials and soon maybe a bigger allocation to SD and still 36% cash as I cant find many doubles. ABX maybe but my screen is half half against them so not as sure as hopefully SD ;D it's fun to learn and improve on my limited knowledge but rewarding job ;D     

[Kraven]

Based on this thread (thanks everyone!), some thought, and Pabrai's presentation, I've come up with this for myself:

 

1st 50% of cash - minimum of 2x in 5 years (15% annual growth, e.g., compounders)

next 20% - minimum of 2x in 3-4 years (20% annual growth)

next 10% - minimum of 2x in 2-3 years (25% annual growth)

next 5% - minimum of 3x in 2-3 years (45% annual growth)

next 5% - minimum of 4x in 2-3 years (60% annual growth)

next 5% - minimum of 5x in 2-3 years (70% annual growth)

last 5% - more than 5x in 2-3 years (>70% annual growth)

 

This should help solidify my thinking and keeping me from being too fully invested at times (e.g., now).

 

I honestly have no clue about things like this and would have no idea how to even begin to categorize investments in this manner. Perhaps I am missing something obvious. What are some examples of things that would be in some of these categories, particularly the latter ones?

 

I hadn't really thought about things this way until I saw Pabrai's video either.  What I had noticed is that when I was investing, I treated the first 50% fairly similar to the last 10%, which I realized was probably not correct.  Said another way, the money should become more and more dear until you are only willing to invest the last 5 or 10% if we are truly at a crazy market low (e.g., 2008 or near-abouts) in order to have money at the opportune time.  This seems to make sense to me, as otherwise you are unlikely to have cash at the right time, without having some macro forecasting going on.

 

For him, he would not consider investing unless it was a double in 2-3 years, and the latter categories are copies of his.  I modified it to fit more in line with my thinking.  Here's my thinking for each category section (and again, I'm trying to modify how I'd been approaching it, so this is still somewhat squishy and changing in my mind):

 

Category 1: I think reasonable expectations of 15% annual returns in investments is the lowest I'm willing to sign up for--or said another way, 10% with a large margin of safety.  Examples here might be FFH/MKL/BRK/LUK ~book value.  Other investments over shorter periods also make some sense in this category, perhaps moderately undervalued moat companies that you expect mean reversion over time (maybe WFC at P/E of 8 with expectations of acceptable growth). 

 

Categories 2 and 3: We've moved up in the chain, so this will probably be shorter term and not buy and hold as much (e.g., strong mean reversion).  Or perhaps, when they mean revert, we end up with category 1 companies if we held them.  Examples may be something like AIG/BAC at the current prices.

 

Category 4: BAC at 7 perhaps?

Category 5: BAC at 5 perhaps?

Categories 6 and 7: Various good companies at the bottom of 2008?

 

Good explanation. I can understand the valuation aspect of it, but have no idea how one would know the timing. Obviously everything is about expectations and expectations can go awry, but still it seems hard for me to contemplate putting a timing aspect on things. Using BAC as an example, I feel as good as anyone that it will be worth around BV and more one of these days, but when?  I have no idea. So I don't know how I would fit it into this.

[racemize]

Good explanation. I can understand the valuation aspect of it, but have no idea how one would know the timing. Obviously everything is about expectations and expectations can go awry, but still it seems hard for me to contemplate putting a timing aspect on things. Using BAC as an example, I feel as good as anyone that it will be worth around BV and more one of these days, but when?  I have no idea. So I don't know how I would fit it into this.

 

I absolutely agree--this seems very difficult to solve and I don't know how well I can do in categorizing investments as I make them.  I guess just use best guess expectations.  Let's say for BAC, we think it is worth BV.  From my own expectations, I presume they will run off most of the legacy asset portions this year and into next year, so a lot of the earning's power should emerge in the 2-3 year time frame.  In that case, I would expect it to trade in the 20-23 range, with the wildcard being all the litigation.  Roughly, we could put BAC in the third category, in that case, whereas when it was under 10 (particularly $5 area), we might have been able to put it in the 3x/4x categories.

 

Even so, it is less about categorizing the investment, but more valuing the remaining cash.  For example, if I'm at 100% cash, I probably need to buy some stocks, and my bar will be lower (e.g., in a high market, you should still own some amount of stocks).  Where this model seems particularly useful is when it saves me from accepting an expected 15% return (such as buying FFH/MKL/BRK) when I only have 10% cash left. 

 

Thus, I agree that the numbers are too specific given the complexity, but it helps with framing.

[racemize]

following on the above, those latter categories also stop me from buying stocks if I don't think they are a 3x, 4x, or 5x.  e.g., as Pabrai said in the video, he doesn't want an idea where the stock sells at 10 and is worth 14, he wants one where it sells at 10 and is worth his valuation multiple (2x for his first 75%, 3x for the next 10%, etc.).

[LC]

Roughly, we could put BAC in the third category, in that case, whereas when it was under 10 (particularly $5 area), we might have been able to put it in the 3x/4x categories.

 

 

This comment got me thinking about how to "average up" into investments. If an investment goes from a 6x to a 3x you would average into it, despite the price having just doubled.

 

Averaging down seems easier compared to averaging up for investors. I know for myself, if nothing has changed value-wise, I will average down after a 20% drop. But buying more after a 20% rise is more difficult. Using Pabrai's framework makes it easier psychologically to average up!

[hyten1]

guys i know this sounds good in theory ... but in practice? (I understand why you would do it)

 

i mean take 2008 and 2009 for example tons of stock were on sale, i put all my money to work during that time (0% cash by the time it was mid 2009). basically i was looking for whatever was cheap within my circle of competence. and there were quite a few (don't want to sound like it was easy for me at the time, eventhough i was putting money to work, it was not easy, your brain says "this is crazy cheap" but your heart goes crazy seeing the stock drop like it did during 2008, 2009)

 

i just find it difficult let say you have put in 90% of your money and you come up with a good investment that will ONLY make 50% annualized, do you pass it up :)

 

because you are waiting for the 70% :)

 

 

[Packer16]

In theory this sounds good but how do you know when the undervaluation will be realized.  I'll give you an example.  Lin TV is has about an 81% appreciation potential to reach my target of current EBITDA multiple of 9.0.  However, it has grown its cash flow about 54% over the past 6 years.  Do I use 80% or more for the growth and over what period?  The past growth has been good but I think the growth may decline in the future.  Do I need to come up with a growth forecast to use this?  If so, I may have a hard time. 

 

For the BV compounders, I can see how the metric can make sense.  So lets say the typical compounder (FFH) can make 15% so you buy only under book?  What if nothing is under book (like now) would you be all in cash?  Are these only buy target numbers or sell targets also?

 

Packer

[biaggio]

In theory this sounds good but how do you know when the undervaluation will be realized.  I'll give you an example.  Lin TV is has about an 81% appreciation potential to reach my target of current EBITDA multiple of 9.0.  However, it has grown its cash flow about 54% over the past 6 years.  Do I use 80% or more for the growth and over what period?  The past growth has been good but I think the growth may decline in the future.  Do I need to come up with a growth forecast to use this?  If so, I may have a hard time. 

 

For the BV compounders, I can see how the metric can make sense.  So lets say the typical compounder (FFH) can make 15% so you buy only under book?  What if nothing is under book (like now) would you be all in cash?  Are these only buy target numbers or sell targets also?

 

Packer

 

I find Allocation and sizing of positions interesting.

 

I think the idea proposed would be that if you had an opportunities like LinTV that you thought had 81% appreciation potential- then you would estimate over what period you expect to realize this---I use 3 years but who knows---not terribly scientific in that you are guessing appreciation potential + time--- so 81% over 3 years (I would take that) would be >25% per year return so by the above thinking you would invest up to 90% of your portfolio in this and leave 10% in cash.

 

Being the coward that I am, there is no way I would put 90% of my networth in 1 position. It would be sweet if you had 5-10 high quality business selling at such a discount then I would allocate the 90% into these.

 

Howard Marks would add that it would be wise to measure the temperature/risk of the market as well---so I would propose that you would need to factor in the level of fear and greed---go all in when there is a lot of fear and market dislocations like in 2008/2009.

 

There is a lot of estimating/guessing, personal bias and other things that can go wrong which probably what makes it seem not practical. But it may be helpful to have it as a framework. Something to think about + so that you are prepared when the $hit hits the fan as it always does. I find that I always under invest, always hoping/wishing for lower prices (but if you think you can get >25% what else is there to worry about---I know there is always something)

 

Incidently everyone at FFH AGM, both the experts and other attendees seemed pretty pessimistic---most were 30-50% in cash

[Packer16]

I must be the contrarian to the experts and attendees, I am 100% invested as are some of my fellow attendees.  As some of my stock rise I want to be prepared to redeploy.  FFH and LUK sound like good alternatives to cash.

 

Packer